China Feihe (HKG:6186) Could Easily Take On More 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that China Feihe Limited (HKG:6186) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for China Feihe

What Is China Feihe's Debt?

You can click the graphic below for the historical numbers, but it shows that China Feihe had CN¥1.18b of debt in December 2020, down from CN¥4.81b, one year before. However, it does have CN¥16.4b in cash offsetting this, leading to net cash of CN¥15.2b.

How Strong Is China Feihe's Balance Sheet?

The latest balance sheet data shows that China Feihe had liabilities of CN¥7.11b due within a year, and liabilities of CN¥2.03b falling due after that. On the other hand, it had cash of CN¥16.4b and CN¥593.5m worth of receivables due within a year. So it can boast CN¥7.86b more liquid assets than total liabilities.

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

On top of that, China Feihe grew its EBIT by 44% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Feihe 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China Feihe 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 last three years, China Feihe recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China Feihe has net cash of CN¥15.2b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥6.9b, being 86% of its EBIT. So we don't think China Feihe's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with China Feihe .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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