Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Asia Cement (China) Holdings Corporation (HKG:743) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Asia Cement (China) Holdings's Debt?
As you can see below, Asia Cement (China) Holdings had CN¥2.77b of debt at September 2021, down from CN¥6.27b a year prior. However, its balance sheet shows it holds CN¥6.59b in cash, so it actually has CN¥3.83b net cash.
A Look At Asia Cement (China) Holdings' Liabilities
Zooming in on the latest balance sheet data, we can see that Asia Cement (China) Holdings had liabilities of CN¥3.42b due within 12 months and liabilities of CN¥1.24b due beyond that. Offsetting this, it had CN¥6.59b in cash and CN¥3.76b in receivables that were due within 12 months. So it can boast CN¥5.70b more liquid assets than total liabilities.
This luscious liquidity implies that Asia Cement (China) Holdings' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Asia Cement (China) Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
But the other side of the story is that Asia Cement (China) Holdings saw its EBIT decline by 9.2% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Asia Cement (China) Holdings 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Asia Cement (China) 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. Over the last three years, Asia Cement (China) Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While we empathize with investors who find debt concerning, you should keep in mind that Asia Cement (China) Holdings has net cash of CN¥3.83b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥3.4b, being 107% of its EBIT. So is Asia Cement (China) 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 Asia Cement (China) Holdings is showing 2 warning signs 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. 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.