We Think Tsingtao Brewery (HKG:168) Can Manage Its Debt With Ease

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Tsingtao Brewery Company Limited (HKG:168) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tsingtao Brewery

What Is Tsingtao Brewery's Net Debt?

As you can see below, Tsingtao Brewery had CN¥254.5m of debt at September 2022, down from CN¥1.30b a year prior. But on the other hand it also has CN¥24.8b in cash, leading to a CN¥24.6b net cash position.

How Healthy Is Tsingtao Brewery's Balance Sheet?

We can see from the most recent balance sheet that Tsingtao Brewery had liabilities of CN¥18.1b falling due within a year, and liabilities of CN¥4.37b due beyond that. Offsetting this, it had CN¥24.8b in cash and CN¥836.7m in receivables that were due within 12 months. So it actually has CN¥3.22b more liquid assets than total liabilities.

This short term liquidity is a sign that Tsingtao Brewery could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Tsingtao Brewery has more cash than debt is arguably a good indication that it can manage its debt safely.

While Tsingtao Brewery doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Tsingtao Brewery can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Tsingtao Brewery may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Tsingtao Brewery actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Tsingtao Brewery has net cash of CN¥24.6b, as well as more liquid assets than liabilities. The cherry on top was that in converted 145% of that EBIT to free cash flow, bringing in CN¥4.1b. So is Tsingtao Brewery's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Tsingtao Brewery you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.