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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Weiqiao Textile Company Limited (HKG:2698) 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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Weiqiao Textile Carry?
As you can see below, Weiqiao Textile had CN¥2.98b of debt at June 2019, down from CN¥6.98b a year prior. However, its balance sheet shows it holds CN¥9.95b in cash, so it actually has CN¥6.98b net cash.
A Look At Weiqiao Textile's Liabilities
The latest balance sheet data shows that Weiqiao Textile had liabilities of CN¥6.47b due within a year, and liabilities of CN¥223.5m falling due after that. On the other hand, it had cash of CN¥9.95b and CN¥599.5m worth of receivables due within a year. So it can boast CN¥3.86b more liquid assets than total liabilities.
This luscious liquidity implies that Weiqiao Textile's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, Weiqiao Textile boasts net cash, so it's fair to say it does not have a heavy debt load!
Unfortunately, Weiqiao Textile's EBIT flopped 19% over the last four quarters. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Weiqiao Textile will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Weiqiao Textile 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. Over the last three years, Weiqiao Textile recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case Weiqiao Textile has CN¥6.98b in net cash and a strong balance sheet. And it impressed us with free cash flow of CN¥1.5b, being 90% of its EBIT. So we don't think Weiqiao Textile's use of debt is risky. Given Weiqiao Textile 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.
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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