Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Sanquan Food Co., Ltd. (SZSE:002216) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Sanquan Food
How Much Debt Does Sanquan Food Carry?
As you can see below, at the end of September 2023, Sanquan Food had CN¥250.1m of debt, up from CN¥150.1m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.54b in cash, leading to a CN¥1.29b net cash position.
How Healthy Is Sanquan Food's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Sanquan Food had liabilities of CN¥2.56b due within 12 months and liabilities of CN¥256.0m due beyond that. Offsetting these obligations, it had cash of CN¥1.54b as well as receivables valued at CN¥589.0m due within 12 months. So its liabilities total CN¥679.3m more than the combination of its cash and short-term receivables.
Since publicly traded Sanquan Food shares are worth a total of CN¥10.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Sanquan Food boasts net cash, so it's fair to say it does not have a heavy debt load!
Sanquan Food's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sanquan Food 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sanquan Food 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 most recent three years, Sanquan Food recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Sanquan Food has CN¥1.29b in net cash. And it impressed us with free cash flow of CN¥268m, being 69% of its EBIT. So we don't think Sanquan Food's use of debt is risky. 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. Be aware that Sanquan Food is showing 2 warning signs in our investment analysis , and 1 of those is significant...
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.