Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Haidilao International Holding Ltd. (HKG:6862) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Haidilao International Holding's Debt?
You can click the graphic below for the historical numbers, but it shows that Haidilao International Holding had CN¥519.8m of debt in June 2019, down from CN¥1.11b, one year before. However, its balance sheet shows it holds CN¥4.78b in cash, so it actually has CN¥4.26b net cash.
How Healthy Is Haidilao International Holding's Balance Sheet?
The latest balance sheet data shows that Haidilao International Holding had liabilities of CN¥3.92b due within a year, and liabilities of CN¥3.80b falling due after that. Offsetting these obligations, it had cash of CN¥4.78b as well as receivables valued at CN¥833.8m due within 12 months. So it has liabilities totalling CN¥2.12b more than its cash and near-term receivables, combined.
Having regard to Haidilao International Holding's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥164.2b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Haidilao International Holding boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Haidilao International Holding grew its EBIT by 51% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Haidilao International 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Haidilao International 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. In the last three years, Haidilao International Holding created free cash flow amounting to 5.6% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Haidilao International Holding has CN¥4.3b in net cash. And we liked the look of last year's 51% year-on-year EBIT growth. So we don't have any problem with Haidilao International Holding's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Haidilao International Holding, you may well want to click here to check an interactive graph of its earnings per share history.
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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