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. We note that China Feihe Limited (HKG:6186) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for China Feihe
How Much Debt Does China Feihe Carry?
You can click the graphic below for the historical numbers, but it shows that China Feihe had CN¥934.2m of debt in December 2021, down from CN¥1.18b, one year before. But it also has CN¥17.2b in cash to offset that, meaning it has CN¥16.2b net cash.
How Strong Is China Feihe's Balance Sheet?
We can see from the most recent balance sheet that China Feihe had liabilities of CN¥6.94b falling due within a year, and liabilities of CN¥2.14b due beyond that. On the other hand, it had cash of CN¥17.2b and CN¥774.4m worth of receivables due within a year. So it actually has CN¥8.87b more liquid assets than total liabilities.
This excess liquidity suggests that China Feihe is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that China Feihe has more cash than debt is arguably a good indication that it can manage its debt safely.
And we also note warmly that China Feihe grew its EBIT by 16% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China Feihe's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China Feihe 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. During the last three years, China Feihe produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
While it is always sensible to investigate a company's debt, in this case China Feihe has CN¥16.2b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in CN¥4.8b. So is China Feihe's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for China Feihe you should be aware of, and 1 of them is a bit unpleasant.
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.
New: AI Stock Screener & Alerts
Our new AI Stock Screener scans the market every day to uncover opportunities.
• Dividend Powerhouses (3%+ Yield)
• Undervalued Small Caps with Insider Buying
• High growth Tech and AI Companies
Or build your own from over 50 metrics.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About SEHK:6186
China Feihe
An investment holding company, produces and sells infant milk formula products in Mainland China, Canada, and the United States.
Flawless balance sheet and undervalued.