Dongwu Cement International (HKG:695) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Dongwu Cement International Limited (HKG:695) 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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Dongwu Cement International

What Is Dongwu Cement International's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Dongwu Cement International had CN¥56.1m of debt in June 2020, down from CN¥58.8m, one year before. However, it does have CN¥281.4m in cash offsetting this, leading to net cash of CN¥225.3m.

How Healthy Is Dongwu Cement International's Balance Sheet?

According to the last reported balance sheet, Dongwu Cement International had liabilities of CN¥209.4m due within 12 months, and liabilities of CN¥27.4m due beyond 12 months. Offsetting this, it had CN¥281.4m in cash and CN¥153.6m in receivables that were due within 12 months. So it actually has CN¥198.2m more liquid assets than total liabilities.

This luscious liquidity implies that Dongwu Cement International's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, Dongwu Cement International boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Dongwu Cement International if management cannot prevent a repeat of the 25% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Dongwu Cement International will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Dongwu Cement International 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, Dongwu Cement International recorded free cash flow worth a fulsome 82% 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 it is always sensible to investigate a company's debt, in this case Dongwu Cement International has CN¥225.3m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in CN¥50m. So we don't think Dongwu Cement International's use of debt is risky. 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. Case in point: We've spotted 2 warning signs for Dongwu Cement International you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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