New World Department Store China (HKG:825) Has A Somewhat Strained Balance Sheet
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. 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. We note that New World Department Store China Limited (HKG:825) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for New World Department Store China
What Is New World Department Store China's Debt?
As you can see below, New World Department Store China had HK$1.63b of debt at June 2019, down from HK$1.88b a year prior. But it also has HK$1.87b in cash to offset that, meaning it has HK$238.7m net cash.
How Healthy Is New World Department Store China's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that New World Department Store China had liabilities of HK$4.65b due within 12 months and liabilities of HK$1.31b due beyond that. Offsetting these obligations, it had cash of HK$1.87b as well as receivables valued at HK$66.5m due within 12 months. So its liabilities total HK$4.02b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the HK$2.07b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet." So we definitely think shareholders need to watch this one closely. After all, New World Department Store China would likely require a major re-capitalisation if it had to pay its creditors today. New World Department Store China boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
The good news is that New World Department Store China has increased its EBIT by 3.3% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since New World Department Store China will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While New World Department Store China 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, New World Department Store China reported free cash flow worth 5.0% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
Summing up
While New World Department Store China does have more liabilities than liquid assets, it also has net cash of HK$238.7m. On top of that, it increased its EBIT by 3.3% in the last twelve months. Despite its cash we think that New World Department Store China seems to struggle to handle its total liabilities, so we are wary of the stock. Over time, share prices tend to follow earnings per share, so if you're interested in New World Department Store China, you may well want to click here to check an interactive graph of its earnings per share history.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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.
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. Thank you for reading.
