Is Alibaba Group Holding (NYSE:BABA) 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.' 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. We note that Alibaba Group Holding Limited (NYSE:BABA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Alibaba Group Holding

What Is Alibaba Group Holding's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Alibaba Group Holding had CN¥207.9b of debt, an increase on CN¥165.5b, over one year. However, it does have CN¥448.9b in cash offsetting this, leading to net cash of CN¥241.0b.

How Healthy Is Alibaba Group Holding's Balance Sheet?

According to the last reported balance sheet, Alibaba Group Holding had liabilities of CN¥462.9b due within 12 months, and liabilities of CN¥268.8b due beyond 12 months. Offsetting this, it had CN¥448.9b in cash and CN¥68.9b in receivables that were due within 12 months. So it has liabilities totalling CN¥213.9b more than its cash and near-term receivables, combined.

Since publicly traded Alibaba Group Holding shares are worth a very impressive total of CN¥1.35t, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Alibaba Group Holding boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Alibaba Group Holding grew its EBIT by 3.6% 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 it is future earnings, more than anything, that will determine Alibaba Group Holding'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Over the last three years, Alibaba Group Holding 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

Although Alibaba Group Holding'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¥241.0b. And it impressed us with free cash flow of CN¥126b, being 111% of its EBIT. So we don't think Alibaba Group Holding's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Alibaba Group Holding , and understanding them should be part of your investment process.

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.