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China Communications Services (HKG:552) Could Easily Take On More Debt

Simply Wall St

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies China Communications Services Corporation Limited (HKG:552) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 China Communications Services

What Is China Communications Services's Debt?

The image below, which you can click on for greater detail, shows that at December 2018 China Communications Services had debt of CN¥470.9m, up from CN¥326.5m in one year. However, it does have CN¥21.2b in cash offsetting this, leading to net cash of CN¥20.7b.

SEHK:552 Historical Debt, July 31st 2019

How Healthy Is China Communications Services's Balance Sheet?

We can see from the most recent balance sheet that China Communications Services had liabilities of CN¥46.7b falling due within a year, and liabilities of CN¥1.37b due beyond that. Offsetting these obligations, it had cash of CN¥21.2b as well as receivables valued at CN¥36.1b due within 12 months. So it can boast CN¥9.12b more liquid assets than total liabilities.

This excess liquidity suggests that China Communications Services is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, China Communications Services boasts net cash, so it's fair to say it does not have a heavy debt load!

China Communications Services's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Communications Services can strengthen its balance sheet over time. 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 China Communications Services 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. Over the last three years, China Communications Services actually produced more free cash flow than EBIT. 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 we empathize with investors who find debt concerning, you should keep in mind that China Communications Services has net cash of CN¥21b, as well as more liquid assets than liabilities. The cherry on top was that in converted 162% of that EBIT to free cash flow, bringing in CN¥3.3b. So is China Communications Services's debt a risk? It doesn't seem so to us. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check China Communications Services's dividend history, without delay!

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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 editorial-team@simplywallst.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.