Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies China BlueChemical Ltd. (HKG:3983) makes use of debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does China BlueChemical Carry?
As you can see below, China BlueChemical had CN¥785.0m of debt at December 2018, down from CN¥2.21b a year prior. But on the other hand it also has CN¥8.82b in cash, leading to a CN¥8.03b net cash position.
How Strong Is China BlueChemical's Balance Sheet?
We can see from the most recent balance sheet that China BlueChemical had liabilities of CN¥3.73b falling due within a year, and liabilities of CN¥1.09b due beyond that. On the other hand, it had cash of CN¥8.82b and CN¥420.4m worth of receivables due within a year. So it actually has CN¥4.42b more liquid assets than total liabilities.
This surplus liquidity suggests that China BlueChemical's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, China BlueChemical boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that China BlueChemical grew its EBIT by 107% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China BlueChemical's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China BlueChemical 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 two years, China BlueChemical actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While we empathize with investors who find debt concerning, you should keep in mind that China BlueChemical has net cash of CN¥8.0b, as well as more liquid assets than liabilities. The cherry on top was that in converted 129% of that EBIT to free cash flow, bringing in CN¥1.8b. At the end of the day we're not concerned about China BlueChemical's debt. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check China BlueChemical's dividend history, without delay!
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.