Digital China Holdings (HKG:861) Takes On Some Risk With Its Use Of 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.' 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 Digital China Holdings Limited (HKG:861) does use debt in its business. But is this debt a concern to shareholders?

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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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is Digital China Holdings's Debt?

As you can see below, at the end of December 2024, Digital China Holdings had CN¥3.48b of debt, up from CN¥3.28b a year ago. Click the image for more detail. But on the other hand it also has CN¥4.08b in cash, leading to a CN¥596.1m net cash position.

A Look At Digital China Holdings' Liabilities

We can see from the most recent balance sheet that Digital China Holdings had liabilities of CN¥9.87b falling due within a year, and liabilities of CN¥2.93b due beyond that. Offsetting these obligations, it had cash of CN¥4.08b as well as receivables valued at CN¥7.28b due within 12 months. So its liabilities total CN¥1.44b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Digital China Holdings has a market capitalization of CN¥4.72b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Digital China Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Check out our latest analysis for Digital China Holdings

Importantly, Digital China Holdings's EBIT fell a jaw-dropping 86% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Digital China Holdings'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Digital 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, Digital 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.

Summing Up

While Digital China Holdings does have more liabilities than liquid assets, it also has net cash of CN¥596.1m. The cherry on top was that in converted 155% of that EBIT to free cash flow, bringing in CN¥468m. So although we see some areas for improvement, we're not too worried about Digital China Holdings's balance sheet. 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. To that end, you should be aware of the 1 warning sign we've spotted with Digital China Holdings .

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.