Here's Why China Starch Holdings (HKG:3838) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, China Starch Holdings Limited (HKG:3838) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for China Starch Holdings

What Is China Starch Holdings's Net Debt?

As you can see below, China Starch Holdings had CN¥111.2m of debt at December 2021, down from CN¥126.8m a year prior. But on the other hand it also has CN¥1.00b in cash, leading to a CN¥889.8m net cash position.

How Healthy Is China Starch Holdings' Balance Sheet?

According to the last reported balance sheet, China Starch Holdings had liabilities of CN¥894.2m due within 12 months, and liabilities of CN¥333.0m due beyond 12 months. On the other hand, it had cash of CN¥1.00b and CN¥359.3m worth of receivables due within a year. So it actually has CN¥133.1m more liquid assets than total liabilities.

This short term liquidity is a sign that China Starch Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, China Starch Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, China Starch Holdings grew its EBIT by 80% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since China Starch Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Starch 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. In the last three years, China Starch Holdings basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China Starch Holdings has net cash of CN¥889.8m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 80% over the last year. So we don't think China Starch Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with China Starch Holdings (including 1 which doesn't sit too well with us) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.