Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Alibaba Group Holding Limited (NYSE:BABA) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Alibaba Group Holding Carry?
The image below, which you can click on for greater detail, shows that at September 2021 Alibaba Group Holding had debt of CN¥151.8b, up from CN¥121.8b in one year. But on the other hand it also has CN¥459.2b in cash, leading to a CN¥307.5b net cash position.
A Look At Alibaba Group Holding's Liabilities
The latest balance sheet data shows that Alibaba Group Holding had liabilities of CN¥387.9b due within a year, and liabilities of CN¥239.9b falling due after that. On the other hand, it had cash of CN¥459.2b and CN¥56.9b worth of receivables due within a year. So its liabilities total CN¥111.6b more than the combination of its cash and short-term receivables.
Of course, Alibaba Group Holding has a titanic market capitalization of CN¥1.99t, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Alibaba Group Holding also has more cash than debt, so we're pretty confident it can manage its debt safely.
Fortunately, Alibaba Group Holding grew its EBIT by 8.7% 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 ultimately the future profitability of the business will decide if Alibaba Group Holding 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 company can only pay off debt with cold hard cash, not accounting profits. Alibaba Group Holding 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, Alibaba Group Holding 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.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Alibaba Group Holding has CN¥307.5b in net cash. The cherry on top was that in converted 161% of that EBIT to free cash flow, bringing in CN¥154b. So is Alibaba Group Holding'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. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Alibaba Group Holding .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.