Is China BlueChemical (HKG:3983) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies China BlueChemical Ltd. (HKG:3983) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China BlueChemical

What Is China BlueChemical's Debt?

You can click the graphic below for the historical numbers, but it shows that China BlueChemical had CN¥921.1m of debt in June 2021, down from CN¥2.03b, one year before. But it also has CN¥10.1b in cash to offset that, meaning it has CN¥9.15b net cash.

A Look At China BlueChemical's Liabilities

Zooming in on the latest balance sheet data, we can see that China BlueChemical had liabilities of CN¥3.86b due within 12 months and liabilities of CN¥194.9m due beyond that. Offsetting this, it had CN¥10.1b in cash and CN¥1.01b in receivables that were due within 12 months. So it can boast CN¥7.02b more liquid assets than total liabilities.

This surplus strongly suggests that China BlueChemical has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, China BlueChemical boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, China BlueChemical grew its EBIT by 134% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 BlueChemical 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 BlueChemical 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 last three years, China BlueChemical recorded free cash flow worth a fulsome 97% 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 BlueChemical has net cash of CN¥9.15b, as well as more liquid assets than liabilities. The cherry on top was that in converted 97% of that EBIT to free cash flow, bringing in CN¥1.6b. At the end of the day we're not concerned about China BlueChemical's debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with China BlueChemical (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.