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.' 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, CIMC Enric Holdings Limited (HKG:3899) does carry debt. But the more important question is: how much risk is that debt creating?
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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is CIMC Enric Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that CIMC Enric Holdings had debt of CN¥1.16b at the end of June 2019, a reduction from CN¥1.79b over a year. But on the other hand it also has CN¥2.68b in cash, leading to a CN¥1.52b net cash position.
How Healthy Is CIMC Enric Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that CIMC Enric Holdings had liabilities of CN¥7.07b due within 12 months and liabilities of CN¥1.53b due beyond that. Offsetting these obligations, it had cash of CN¥2.68b as well as receivables valued at CN¥4.53b due within 12 months. So its liabilities total CN¥1.38b more than the combination of its cash and short-term receivables.
Since publicly traded CIMC Enric Holdings shares are worth a total of CN¥8.13b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, CIMC Enric Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that CIMC Enric Holdings has boosted its EBIT by 44%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CIMC Enric Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. CIMC Enric 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, CIMC Enric Holdings generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While CIMC Enric Holdings does have more liabilities than liquid assets, it also has net cash of CN¥1.5b. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in CN¥1.3b. So is CIMC Enric Holdings's debt a risk? It doesn't seem so to us. Given CIMC Enric Holdings has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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.
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