Is Alibaba Group Holding (NYSE:BABA) A Risky Investment?

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 Alibaba Group Holding Limited (NYSE:BABA) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt 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 September 2024 Alibaba Group Holding had CN¥202.3b of debt, an increase on CN¥166.7b, over one year. However, its balance sheet shows it holds CN¥388.8b in cash, so it actually has CN¥186.5b net cash.

How Strong Is Alibaba Group Holding's Balance Sheet?

We can see from the most recent balance sheet that Alibaba Group Holding had liabilities of CN¥444.9b falling due within a year, and liabilities of CN¥260.0b due beyond that. Offsetting this, it had CN¥388.8b in cash and CN¥68.9b in receivables that were due within 12 months. So its liabilities total CN¥247.1b more than the combination of its cash and short-term receivables.

Given Alibaba Group Holding has a humongous market capitalization of CN¥1.44t, it's hard to believe these liabilities pose much 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!

But the other side of the story is that Alibaba Group Holding saw its EBIT decline by 2.4% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Alibaba Group Holding 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. 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 conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Alibaba Group Holding does have more liabilities than liquid assets, it also has net cash of CN¥186.5b. And it impressed us with free cash flow of CN¥103b, being 101% of its EBIT. So is Alibaba Group Holding's debt a risk? It doesn't seem so to us. 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. Be aware that Alibaba Group Holding is showing 2 warning signs in our investment analysis , you should know about...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.