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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, China Feihe Limited (HKG:6186) does carry debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for China Feihe

What Is China Feihe's Net 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. However, it does have CN¥16.5b in cash offsetting this, leading to net cash of CN¥15.6b.

How Strong Is China Feihe's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Feihe had liabilities of CN¥6.38b due within 12 months and liabilities of CN¥2.19b due beyond that. Offsetting these obligations, it had cash of CN¥16.5b as well as receivables valued at CN¥445.5m due within 12 months. So it can boast CN¥8.43b 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.

It is just as well that China Feihe's load is not too heavy, because its EBIT was down 23% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 74% 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 it is always sensible to investigate a company's debt, in this case China Feihe has CN¥15.6b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥2.6b, being 74% of its EBIT. So we don't have any problem with China Feihe's use of debt. 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. Be aware that China Feihe is showing 3 warning signs in our investment analysis , and 1 of those is significant...

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.