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'. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Uni-President China Holdings Ltd (HKG:220) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Uni-President China Holdings's Debt?
As you can see below, at the end of June 2019, Uni-President China Holdings had CN¥1.98b of debt, up from CN¥1.4k a year ago. Click the image for more detail. But on the other hand it also has CN¥4.32b in cash, leading to a CN¥2.34b net cash position.
How Healthy Is Uni-President China Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Uni-President China Holdings had liabilities of CN¥6.88b due within 12 months and liabilities of CN¥475.4m due beyond that. Offsetting this, it had CN¥4.32b in cash and CN¥692.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥2.35b more than its cash and near-term receivables, combined.
Of course, Uni-President China Holdings has a market capitalization of CN¥33.0b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Uni-President China Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Uni-President China Holdings grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. 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 Uni-President China Holdings 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Uni-President China 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. Happily for any shareholders, Uni-President China Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
We could understand if investors are concerned about Uni-President China Holdings's liabilities, but we can be reassured by the fact it has has net cash of CN¥2.34b. The cherry on top was that in converted 125% of that EBIT to free cash flow, bringing in CN¥1.4b. So we don't think Uni-President China Holdings's use of debt is risky. 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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Uni-President China Holdings you should know about.
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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