Warren Buffett famously said, '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. We note that Foshan Haitian Flavouring and Food Company Ltd. (SHSE:603288) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Foshan Haitian Flavouring and Food Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2024 Foshan Haitian Flavouring and Food had CN¥683.1m of debt, an increase on CN¥240.8m, over one year. However, it does have CN¥26.9b in cash offsetting this, leading to net cash of CN¥26.2b.
How Healthy Is Foshan Haitian Flavouring and Food's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Foshan Haitian Flavouring and Food had liabilities of CN¥5.85b due within 12 months and liabilities of CN¥447.2m due beyond that. Offsetting this, it had CN¥26.9b in cash and CN¥264.1m in receivables that were due within 12 months. So it actually has CN¥20.8b more liquid assets than total liabilities.
This surplus suggests that Foshan Haitian Flavouring and Food has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Foshan Haitian Flavouring and Food boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Foshan Haitian Flavouring and Food saw its EBIT drop by 3.4% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Foshan Haitian Flavouring and Food'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Foshan Haitian Flavouring and Food may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Foshan Haitian Flavouring and Food recorded free cash flow worth 65% 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 we empathize with investors who find debt concerning, you should keep in mind that Foshan Haitian Flavouring and Food has net cash of CN¥26.2b, as well as more liquid assets than liabilities. So is Foshan Haitian Flavouring and Food's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Foshan Haitian Flavouring and Food you should be aware of, and 1 of them is a bit concerning.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.