Does CITIC Telecom International Holdings (HKG:1883) 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. As with many other companies CITIC Telecom International Holdings Limited (HKG:1883) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for CITIC Telecom International Holdings

How Much Debt Does CITIC Telecom International Holdings Carry?

The image below, which you can click on for greater detail, shows that CITIC Telecom International Holdings had debt of HK$4.52b at the end of December 2022, a reduction from HK$5.45b over a year. However, because it has a cash reserve of HK$1.98b, its net debt is less, at about HK$2.54b.

How Strong Is CITIC Telecom International Holdings' Balance Sheet?

According to the last reported balance sheet, CITIC Telecom International Holdings had liabilities of HK$2.80b due within 12 months, and liabilities of HK$4.91b due beyond 12 months. On the other hand, it had cash of HK$1.98b and HK$1.53b worth of receivables due within a year. So it has liabilities totalling HK$4.20b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since CITIC Telecom International Holdings has a market capitalization of HK$11.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

CITIC Telecom International Holdings has net debt of just 1.0 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 7.1 times the interest expense over the last year. The good news is that CITIC Telecom International Holdings has increased its EBIT by 9.5% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CITIC Telecom International Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, CITIC Telecom International Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

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. And we also thought its net debt to EBITDA was a positive. Taking all this data into account, it seems to us that CITIC Telecom International Holdings takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. Given CITIC Telecom International Holdings has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.