These 4 Measures Indicate That China Feihe (HKG:6186) Is Using Debt Reasonably Well
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.' 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. We note that China Feihe Limited (HKG:6186) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 as of December 2022 China Feihe had CN„1.31b of debt, an increase on CN„934.2m, over one year. However, it does have CN„19.1b in cash offsetting this, leading to net cash of CN„17.8b.
How Healthy Is China Feihe's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that China Feihe had liabilities of CN„7.46b due within 12 months and liabilities of CN„2.58b due beyond that. Offsetting these obligations, it had cash of CN„19.1b as well as receivables valued at CN„616.5m due within 12 months. So it can boast CN„9.66b more liquid assets than total liabilities.
This excess liquidity suggests that China Feihe is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, China Feihe boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that China Feihe's load is not too heavy, because its EBIT was down 29% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. 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, while the tax-man may adore accounting profits, lenders only accept 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. Over the most recent three years, China Feihe recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that China Feihe has net cash of CN„17.8b, as well as more liquid assets than liabilities. So we don't have any problem with China Feihe's use of debt. 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 - China Feihe has 1 warning sign we think you should be aware of.
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.
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.