These 4 Measures Indicate That China Mobile (HKG:941) Is Using Debt Safely

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that China Mobile Limited (HKG:941) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Mobile

How Much Debt Does China Mobile Carry?

The image below, which you can click on for greater detail, shows that at June 2023 China Mobile had debt of CN¥35.3b, up from none in one year. However, its balance sheet shows it holds CN¥354.8b in cash, so it actually has CN¥319.5b net cash.

A Look At China Mobile's Liabilities

Zooming in on the latest balance sheet data, we can see that China Mobile had liabilities of CN¥557.9b due within 12 months and liabilities of CN¥96.8b due beyond that. Offsetting this, it had CN¥354.8b in cash and CN¥115.2b in receivables that were due within 12 months. So its liabilities total CN¥184.7b more than the combination of its cash and short-term receivables.

Of course, China Mobile has a titanic market capitalization of CN¥1.34t, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, China Mobile boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, China Mobile grew its EBIT by 5.7% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Mobile 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 company can only pay off debt with cold hard cash, not accounting profits. China Mobile 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. During the last three years, China Mobile generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although China Mobile's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥319.5b. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in CN¥114b. So is China Mobile's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for China Mobile that you should be aware of before investing here.

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.