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

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies China Starch Holdings Limited (HKG:3838) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for China Starch Holdings

What Is China Starch Holdings's Net Debt?

As you can see below, at the end of December 2023, China Starch Holdings had CN¥559.4m of debt, up from CN¥285.9m a year ago. Click the image for more detail. But it also has CN¥899.8m in cash to offset that, meaning it has CN¥340.5m net cash.

How Healthy Is China Starch Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Starch Holdings had liabilities of CN¥1.19b due within 12 months and liabilities of CN¥223.7m due beyond that. Offsetting this, it had CN¥899.8m in cash and CN¥417.7m in receivables that were due within 12 months. So its liabilities total CN¥98.5m more than the combination of its cash and short-term receivables.

Of course, China Starch Holdings has a market capitalization of CN¥1.03b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, China Starch Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for China Starch Holdings if management cannot prevent a repeat of the 75% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Starch Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While China Starch Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, China Starch Holdings recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that China Starch Holdings has CN¥340.5m in net cash. And it impressed us with free cash flow of -CN¥8.3m, being 66% of its EBIT. So we don't have any problem with China Starch Holdings's use of debt. There's no doubt that we learn most about debt from the balance sheet. 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 2 warning signs for China Starch Holdings you should know about.

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.