Does DaChan Food (Asia) (HKG:3999) Have A Healthy Balance Sheet?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies DaChan Food (Asia) Limited (HKG:3999) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for DaChan Food (Asia)

How Much Debt Does DaChan Food (Asia) Carry?

The image below, which you can click on for greater detail, shows that DaChan Food (Asia) had debt of CN¥900.1m at the end of September 2020, a reduction from CN¥1.04b over a year. However, because it has a cash reserve of CN¥612.4m, its net debt is less, at about CN¥287.7m.

How Healthy Is DaChan Food (Asia)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that DaChan Food (Asia) had liabilities of CN¥1.49b due within 12 months and liabilities of CN¥593.9m due beyond that. Offsetting these obligations, it had cash of CN¥612.4m as well as receivables valued at CN¥799.7m due within 12 months. So its liabilities total CN¥675.7m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥766.7m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

DaChan Food (Asia) has a low net debt to EBITDA ratio of only 0.48. And its EBIT covers its interest expense a whopping 19.2 times over. So we're pretty relaxed about its super-conservative use of debt. Better yet, DaChan Food (Asia) grew its EBIT by 141% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since DaChan Food (Asia) will need earnings to service that debt. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, DaChan Food (Asia) reported free cash flow worth 20% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

DaChan Food (Asia)'s interest cover was a real positive on this analysis, as was its EBIT growth rate. Having said that, its level of total liabilities somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that DaChan Food (Asia) is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Case in point: We've spotted 1 warning sign for DaChan Food (Asia) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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