China Aluminum Cans Holdings (HKG:6898) Has A Rock Solid Balance Sheet

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.' 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 can see that China Aluminum Cans Holdings Limited (HKG:6898) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for China Aluminum Cans Holdings

What Is China Aluminum Cans Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 China Aluminum Cans Holdings had HK$11.9m of debt, an increase on none, over one year. However, it does have HK$103.7m in cash offsetting this, leading to net cash of HK$91.9m.

A Look At China Aluminum Cans Holdings' Liabilities

The latest balance sheet data shows that China Aluminum Cans Holdings had liabilities of HK$36.2m due within a year, and liabilities of HK$6.04m falling due after that. Offsetting these obligations, it had cash of HK$103.7m as well as receivables valued at HK$15.5m due within 12 months. So it can boast HK$77.1m more liquid assets than total liabilities.

This excess liquidity suggests that China Aluminum Cans Holdings is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, China Aluminum Cans Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that China Aluminum Cans Holdings has increased its EBIT by 8.6% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Aluminum Cans Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Aluminum Cans Holdings 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. Happily for any shareholders, China Aluminum Cans Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China Aluminum Cans Holdings has net cash of HK$91.9m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of HK$40m, being 192% of its EBIT. So is China Aluminum Cans Holdings's debt a risk? It doesn't seem so to us. 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. Be aware that China Aluminum Cans Holdings is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

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. 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.
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