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

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Dongwu Cement International Limited (HKG:695) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Dongwu Cement International

What Is Dongwu Cement International's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Dongwu Cement International had CN¥65.2m of debt, an increase on CN¥37.0m, over one year. However, it does have CN¥403.0m in cash offsetting this, leading to net cash of CN¥337.8m.

How Healthy Is Dongwu Cement International's Balance Sheet?

The latest balance sheet data shows that Dongwu Cement International had liabilities of CN¥241.5m due within a year, and liabilities of CN¥34.3m falling due after that. Offsetting this, it had CN¥403.0m in cash and CN¥126.4m in receivables that were due within 12 months. So it can boast CN¥253.7m more liquid assets than total liabilities.

It's good to see that Dongwu Cement International has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. 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 38% 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. There's no doubt that we learn most about debt from the balance sheet. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Dongwu Cement International has CN¥337.8m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 128% of that EBIT to free cash flow, bringing in CN¥104m. So we don't think Dongwu Cement International's use of debt is risky. 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. Be aware that Dongwu Cement International is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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