Here's Why China Feihe (HKG:6186) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that China Feihe Limited (HKG:6186) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Feihe

How Much Debt Does China Feihe Carry?

The image below, which you can click on for greater detail, shows that at December 2023 China Feihe had debt of CN¥1.38b, up from CN¥1.31b in one year. But it also has CN¥19.1b in cash to offset that, meaning it has CN¥17.7b net cash.

A Look At China Feihe's Liabilities

The latest balance sheet data shows that China Feihe had liabilities of CN¥7.38b due within a year, and liabilities of CN¥2.48b falling due after that. Offsetting this, it had CN¥19.1b in cash and CN¥431.2m in receivables that were due within 12 months. So it actually has CN¥9.68b more liquid assets than total liabilities.

This surplus liquidity suggests that China Feihe's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, China Feihe boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for China Feihe if management cannot prevent a repeat of the 42% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 most recent three years, China Feihe recorded free cash flow worth 76% 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 we empathize with investors who find debt concerning, you should keep in mind that China Feihe has net cash of CN¥17.7b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥4.4b, being 76% of its EBIT. So we don't think China Feihe's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for China Feihe that you should be aware of before investing here.

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. 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.