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 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. Importantly, Chaozhou Three-Circle (Group) Co.,Ltd. (SZSE:300408) does carry debt. But the real question is whether this debt is making the company risky.
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, 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.
View our latest analysis for Chaozhou Three-Circle (Group)Ltd
How Much Debt Does Chaozhou Three-Circle (Group)Ltd Carry?
The image below, which you can click on for greater detail, shows that at September 2023 Chaozhou Three-Circle (Group)Ltd had debt of CN¥895.8m, up from CN¥99.5m in one year. But it also has CN¥9.90b in cash to offset that, meaning it has CN¥9.01b net cash.
How Healthy Is Chaozhou Three-Circle (Group)Ltd's Balance Sheet?
According to the last reported balance sheet, Chaozhou Three-Circle (Group)Ltd had liabilities of CN¥2.27b due within 12 months, and liabilities of CN¥1.09b due beyond 12 months. On the other hand, it had cash of CN¥9.90b and CN¥2.14b worth of receivables due within a year. So it can boast CN¥8.69b more liquid assets than total liabilities.
This surplus suggests that Chaozhou Three-Circle (Group)Ltd is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Chaozhou Three-Circle (Group)Ltd boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Chaozhou Three-Circle (Group)Ltd's load is not too heavy, because its EBIT was down 42% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Chaozhou Three-Circle (Group)Ltd'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Chaozhou Three-Circle (Group)Ltd 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. In the last three years, Chaozhou Three-Circle (Group)Ltd's free cash flow amounted to 20% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing Up
While it is always sensible to investigate a company's debt, in this case Chaozhou Three-Circle (Group)Ltd has CN¥9.01b in net cash and a decent-looking balance sheet. So we don't have any problem with Chaozhou Three-Circle (Group)Ltd's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Chaozhou Three-Circle (Group)Ltd you should know about.
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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.