Is Fufeng Group (HKG:546) A Risky Investment?

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 Fufeng Group Limited (HKG:546) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Fufeng Group

What Is Fufeng Group's Debt?

As you can see below, at the end of December 2022, Fufeng Group had CN¥6.03b of debt, up from CN¥4.30b a year ago. Click the image for more detail. But on the other hand it also has CN¥7.08b in cash, leading to a CN¥1.06b net cash position.

How Strong Is Fufeng Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Fufeng Group had liabilities of CN¥9.39b due within 12 months and liabilities of CN¥1.51b due beyond that. Offsetting these obligations, it had cash of CN¥7.08b as well as receivables valued at CN¥1.74b due within 12 months. So it has liabilities totalling CN¥2.07b more than its cash and near-term receivables, combined.

Given Fufeng Group has a market capitalization of CN¥10.4b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Fufeng Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Fufeng Group grew its EBIT by 186% over twelve months. 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 Fufeng Group 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Fufeng Group 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, Fufeng Group recorded free cash flow worth 55% 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

Although Fufeng Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥1.06b. And we liked the look of last year's 186% year-on-year EBIT growth. So we don't think Fufeng Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Fufeng Group 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.