The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, COFCO Meat Holdings Limited (HKG:1610) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is COFCO Meat Holdings's Debt?
As you can see below, at the end of June 2019, COFCO Meat Holdings had CN¥4.49b of debt, up from CN¥3.44b a year ago. Click the image for more detail. However, it also had CN¥884.1m in cash, and so its net debt is CN¥3.61b.
A Look At COFCO Meat Holdings's Liabilities
According to the last reported balance sheet, COFCO Meat Holdings had liabilities of CN¥4.30b due within 12 months, and liabilities of CN¥1.64b due beyond 12 months. Offsetting this, it had CN¥884.1m in cash and CN¥206.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.85b.
This is a mountain of leverage relative to its market capitalization of CN¥8.08b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 COFCO Meat Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, COFCO Meat Holdings reported revenue of CN¥8.3b, which is a gain of 20%. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months COFCO Meat Holdings produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥644m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥1.3b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how COFCO Meat Holdings's profit, revenue, and operating cashflow have changed over the last few years.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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