CITIC Telecom International Holdings (HKG:1883) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, CITIC Telecom International Holdings Limited (HKG:1883) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Our analysis indicates that 1883 is potentially undervalued!

What Is CITIC Telecom International Holdings's Debt?

As you can see below, CITIC Telecom International Holdings had HK$5.13b of debt at June 2022, down from HK$5.67b a year prior. However, because it has a cash reserve of HK$1.72b, its net debt is less, at about HK$3.41b.

How Strong Is CITIC Telecom International Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CITIC Telecom International Holdings had liabilities of HK$2.75b due within 12 months and liabilities of HK$5.32b due beyond that. Offsetting these obligations, it had cash of HK$1.72b as well as receivables valued at HK$1.69b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$4.67b.

While this might seem like a lot, it is not so bad since CITIC Telecom International Holdings has a market capitalization of HK$9.74b, 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 1.4 and interest cover of 6.7 times, it seems to us that CITIC Telecom International Holdings is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Fortunately, CITIC Telecom International Holdings grew its EBIT by 4.7% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine CITIC Telecom International Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, CITIC Telecom International Holdings 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.

Our View

CITIC Telecom International Holdings's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its level of total liabilities. Looking at all the aforementioned factors together, it strikes us that CITIC Telecom International Holdings can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check CITIC Telecom International Holdings's dividend history, without delay!

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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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.