Is China Telecom (HKG:728) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, China Telecom Corporation Limited (HKG:728) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for China Telecom

How Much Debt Does China Telecom Carry?

The image below, which you can click on for greater detail, shows that at March 2024 China Telecom had debt of CN¥9.20b, up from CN¥8.09b in one year. But on the other hand it also has CN¥87.9b in cash, leading to a CN¥78.7b net cash position.

How Strong Is China Telecom's Balance Sheet?

The latest balance sheet data shows that China Telecom had liabilities of CN¥309.4b due within a year, and liabilities of CN¥83.8b falling due after that. Offsetting this, it had CN¥87.9b in cash and CN¥56.6b in receivables that were due within 12 months. So it has liabilities totalling CN¥248.7b more than its cash and near-term receivables, combined.

This deficit isn't so bad because China Telecom is worth a massive CN¥515.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, China Telecom boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that China Telecom saw its EBIT decline by 5.0% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if China Telecom can strengthen its balance sheet over time. 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. China Telecom 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. Happily for any shareholders, China Telecom 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.

Summing Up

While China Telecom does have more liabilities than liquid assets, it also has net cash of CN¥78.7b. And it impressed us with free cash flow of CN¥40b, being 128% of its EBIT. So we are not troubled with China Telecom's debt use. 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. For example - China Telecom has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.