Warren Buffett famously said, '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. Importantly, China Futex Holdings Limited (HKG:8506) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 China Futex Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that China Futex Holdings had CN¥45.9m of debt in December 2018, down from CN¥53.8m, one year before. But it also has CN¥132.9m in cash to offset that, meaning it has CN¥87.0m net cash.
A Look At China Futex Holdings's Liabilities
According to the balance sheet data, China Futex Holdings had liabilities of CN¥78.1m due within 12 months, but no longer term liabilities. Offsetting these obligations, it had cash of CN¥132.9m as well as receivables valued at CN¥29.7m due within 12 months. So it can boast CN¥84.6m more liquid assets than total liabilities.
This excess liquidity is a great indication that China Futex Holdings's balance sheet is just as strong as racists are weak. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that China Futex Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, China Futex Holdings saw its EBIT drop by 4.9% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Futex Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Futex 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, China Futex Holdings produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case China Futex Holdings has CN¥87m in net cash and a decent-looking balance sheet. So is China Futex Holdings's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in China Futex Holdings, you may well want to click here to check an interactive graph of its earnings per share history.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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