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Here's Why China MeiDong Auto Holdings (HKG:1268) Can Manage Its Debt Responsibly

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Simply Wall St
·4 min read
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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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. We note that China MeiDong Auto Holdings Limited (HKG:1268) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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, 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.

View our latest analysis for China MeiDong Auto Holdings

How Much Debt Does China MeiDong Auto Holdings Carry?

As you can see below, China MeiDong Auto Holdings had CN¥1.12b of debt at December 2019, down from CN¥1.18b a year prior. But it also has CN¥1.12b in cash to offset that, meaning it has CN¥6.61m net cash.

SEHK:1268 Historical Debt May 18th 2020
SEHK:1268 Historical Debt May 18th 2020

How Healthy Is China MeiDong Auto Holdings's Balance Sheet?

According to the last reported balance sheet, China MeiDong Auto Holdings had liabilities of CN¥3.18b due within 12 months, and liabilities of CN¥975.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.12b as well as receivables valued at CN¥808.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.22b.

Since publicly traded China MeiDong Auto Holdings shares are worth a total of CN¥16.3b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, China MeiDong Auto Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, China MeiDong Auto Holdings grew its EBIT by 77% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China MeiDong Auto Holdings'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While China MeiDong Auto Holdings 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. Looking at the most recent three years, China MeiDong Auto Holdings recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although China MeiDong Auto Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥6.61m. And we liked the look of last year's 77% year-on-year EBIT growth. So we don't have any problem with China MeiDong Auto Holdings's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for China MeiDong Auto Holdings that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.

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. Thank you for reading.