Is China Feihe (HKG:6186) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Feihe Limited (HKG:6186) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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?

The image below, which you can click on for greater detail, shows that at June 2022 China Feihe had debt of CN¥972.0m, up from CN¥898.2m in one year. But it also has CN¥16.5b in cash to offset that, meaning it has CN¥15.6b net cash.

A Look At China Feihe's Liabilities

We can see from the most recent balance sheet that China Feihe had liabilities of CN¥5.06b falling due within a year, and liabilities of CN¥2.19b due beyond that. Offsetting this, it had CN¥16.5b in cash and CN¥445.5m in receivables that were due within 12 months. So it actually has CN¥9.75b more liquid assets than total liabilities.

This surplus suggests that China Feihe is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, China Feihe boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact China Feihe's saving grace is its low debt levels, because its EBIT has tanked 23% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Over the last three years, China Feihe recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Feihe has net cash of CN¥15.6b, as well as more liquid assets than liabilities. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in CN¥4.8b. So we don't think China Feihe's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for China Feihe that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.