Does New World Department Store China (HKG:825) Have A Healthy 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that New World Department Store China Limited (HKG:825) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for New World Department Store China

What Is New World Department Store China's Net Debt?

The chart below, which you can click on for greater detail, shows that New World Department Store China had HK$1.41b in debt in December 2020; about the same as the year before. However, its balance sheet shows it holds HK$1.84b in cash, so it actually has HK$426.7m net cash.

How Healthy Is New World Department Store China's Balance Sheet?

We can see from the most recent balance sheet that New World Department Store China had liabilities of HK$4.73b falling due within a year, and liabilities of HK$4.68b due beyond that. Offsetting these obligations, it had cash of HK$1.84b as well as receivables valued at HK$104.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$7.46b.

This deficit casts a shadow over the HK$2.14b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, New World Department Store China would probably need a major re-capitalization if its creditors were to demand repayment. New World Department Store China boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Shareholders should be aware that New World Department Store China's EBIT was down 82% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is New World Department Store China's earnings that will influence how the balance sheet holds up in the future. 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. While New World Department Store China 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. In the last three years, New World Department Store China's free cash flow amounted to 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While New World Department Store China does have more liabilities than liquid assets, it also has net cash of HK$426.7m. However, we do find both New World Department Store China's level of total liabilities and its EBIT growth rate troubling. So even though it has net cash, we do think the business has some risks worth watching. 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. To that end, you should be aware of the 1 warning sign we've spotted with New World Department Store China .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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