We Think New World Department Store China (HKG:825) Can Stay On Top Of Its Debt

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 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.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for New World Department Store China

What Is New World Department Store China's 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 2021; about the same as the year before. However, it does have HK$1.55b in cash offsetting this, leading to net cash of HK$137.5m.

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

According to the last reported balance sheet, New World Department Store China had liabilities of HK$4.55b due within 12 months, and liabilities of HK$4.86b due beyond 12 months. Offsetting this, it had HK$1.55b in cash and HK$126.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$7.73b.

The deficiency here weighs heavily on the HK$1.97b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. 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.

It is well worth noting that New World Department Store China's EBIT shot up like bamboo after rain, gaining 62% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since New World Department Store China will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. New World Department Store China 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, New World Department Store China 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 New World Department Store China does have more liabilities than liquid assets, it also has net cash of HK$137.5m. And it impressed us with free cash flow of HK$457m, being 118% of its EBIT. So we are not troubled with New World Department Store China's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - New World Department Store China has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.