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.' 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. We note that Chinese People Holdings Company Limited (HKG:681) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Chinese People Holdings
How Much Debt Does Chinese People Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that Chinese People Holdings had CN¥71.7m of debt in June 2024, down from CN¥81.4m, one year before. But on the other hand it also has CN¥623.0m in cash, leading to a CN¥551.3m net cash position.
A Look At Chinese People Holdings' Liabilities
We can see from the most recent balance sheet that Chinese People Holdings had liabilities of CN¥560.0m falling due within a year, and liabilities of CN¥30.8m due beyond that. On the other hand, it had cash of CN¥623.0m and CN¥172.8m worth of receivables due within a year. So it actually has CN¥205.0m more liquid assets than total liabilities.
This excess liquidity is a great indication that Chinese People Holdings' balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Chinese People Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
Also positive, Chinese People Holdings grew its EBIT by 30% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chinese People Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Chinese People Holdings 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, Chinese People Holdings generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Summing Up
While it is always sensible to investigate a company's debt, in this case Chinese People Holdings has CN¥551.3m in net cash and a strong balance sheet. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in CN¥70m. The bottom line is that Chinese People Holdings's use of debt is absolutely fine. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Chinese People Holdings (of which 1 is a bit concerning!) you should know about.
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.