Is Uni-President China Holdings (HKG:220) Using Too Much Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Uni-President China Holdings Ltd (HKG:220) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Uni-President China Holdings

What Is Uni-President China Holdings's Net Debt?

As you can see below, Uni-President China Holdings had CN¥487.1m of debt at December 2020, down from CN¥1.16b a year prior. However, it does have CN¥2.97b in cash offsetting this, leading to net cash of CN¥2.48b.

How Healthy Is Uni-President China Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Uni-President China Holdings had liabilities of CN¥7.67b due within 12 months and liabilities of CN¥551.8m due beyond that. Offsetting these obligations, it had cash of CN¥2.97b as well as receivables valued at CN¥959.5m due within 12 months. So its liabilities total CN¥4.29b more than the combination of its cash and short-term receivables.

Of course, Uni-President China Holdings has a market capitalization of CN¥34.1b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Uni-President China Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Uni-President China Holdings grew its EBIT at 11% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Uni-President China Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Uni-President China Holdings 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, Uni-President China Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Uni-President China Holdings does have more liabilities than liquid assets, it also has net cash of CN¥2.48b. The cherry on top was that in converted 134% of that EBIT to free cash flow, bringing in CN¥2.9b. So we don't think Uni-President China Holdings's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Uni-President China Holdings .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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.
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