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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Anhui Korrun Co., Ltd. (SZSE:300577) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Anhui Korrun's Net Debt?
As you can see below, Anhui Korrun had CN¥908.3m of debt at September 2023, down from CN¥1.06b a year prior. However, it does have CN¥914.0m in cash offsetting this, leading to net cash of CN¥5.69m.
A Look At Anhui Korrun's Liabilities
Zooming in on the latest balance sheet data, we can see that Anhui Korrun had liabilities of CN¥1.26b due within 12 months and liabilities of CN¥440.7m due beyond that. Offsetting this, it had CN¥914.0m in cash and CN¥518.2m in receivables that were due within 12 months. So its liabilities total CN¥271.5m more than the combination of its cash and short-term receivables.
Of course, Anhui Korrun has a market capitalization of CN¥3.94b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Anhui Korrun also has more cash than debt, so we're pretty confident it can manage its debt safely.
Importantly, Anhui Korrun grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Anhui Korrun'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Anhui Korrun 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. During the last three years, Anhui Korrun produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
We could understand if investors are concerned about Anhui Korrun's liabilities, but we can be reassured by the fact it has has net cash of CN¥5.69m. And we liked the look of last year's 43% year-on-year EBIT growth. So we don't think Anhui Korrun's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Anhui Korrun has 1 warning sign we think you should be aware of.
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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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.
