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

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. As with many other companies China Telecom Corporation Limited (HKG:728) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Telecom

How Much Debt Does China Telecom Carry?

As you can see below, at the end of September 2024, China Telecom had CN¥25.8b of debt, up from CN¥21.0b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥93.9b in cash, so it actually has CN¥68.1b net cash.

How Strong Is China Telecom's Balance Sheet?

We can see from the most recent balance sheet that China Telecom had liabilities of CN¥330.4b falling due within a year, and liabilities of CN¥82.3b due beyond that. On the other hand, it had cash of CN¥93.9b and CN¥74.8b worth of receivables due within a year. So its liabilities total CN¥244.0b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since China Telecom has a huge market capitalization of CN¥573.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, China Telecom also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that China Telecom has increased its EBIT by 2.2% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China Telecom's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. While China Telecom has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, China Telecom 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 China Telecom does have more liabilities than liquid assets, it also has net cash of CN¥68.1b. And it impressed us with free cash flow of CN¥35b, being 103% of its EBIT. So we don't have any problem with China Telecom's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for China Telecom that 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.