We Think Dongwu Cement International (HKG:695) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Dongwu Cement International Limited (HKG:695) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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, 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.

Check out our latest analysis for Dongwu Cement International

What Is Dongwu Cement International's Debt?

As you can see below, at the end of December 2021, Dongwu Cement International had HK$136.7m of debt, up from HK$78.2m a year ago. Click the image for more detail. But on the other hand it also has HK$496.9m in cash, leading to a HK$360.3m net cash position.

How Healthy Is Dongwu Cement International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dongwu Cement International had liabilities of HK$388.9m due within 12 months and liabilities of HK$43.0m due beyond that. Offsetting these obligations, it had cash of HK$496.9m as well as receivables valued at HK$73.0m due within 12 months. So it can boast HK$138.0m more liquid assets than total liabilities.

This surplus suggests that Dongwu Cement International has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Dongwu Cement International has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Dongwu Cement International's load is not too heavy, because its EBIT was down 24% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Dongwu Cement International's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Dongwu Cement International 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, Dongwu Cement International actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Dongwu Cement International has HK$360.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of -HK$14m, being 113% of its EBIT. So we don't have any problem with Dongwu Cement International's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Dongwu Cement International is showing 1 warning sign in our investment analysis , you should know about...

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. 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.