David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Luzhou Laojiao Co.,Ltd (SZSE:000568) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Luzhou LaojiaoLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Luzhou LaojiaoLtd had CN¥13.5b of debt, an increase on CN¥12.1b, over one year. However, it does have CN¥33.4b in cash offsetting this, leading to net cash of CN¥19.9b.

How Strong Is Luzhou LaojiaoLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Luzhou LaojiaoLtd had liabilities of CN¥10.1b due within 12 months and liabilities of CN¥12.2b due beyond that. Offsetting this, it had CN¥33.4b in cash and CN¥5.38b in receivables that were due within 12 months. So it actually has CN¥16.5b more liquid assets than total liabilities.

This short term liquidity is a sign that Luzhou LaojiaoLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Luzhou LaojiaoLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Luzhou LaojiaoLtd has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Luzhou LaojiaoLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Luzhou LaojiaoLtd 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, Luzhou LaojiaoLtd recorded free cash flow worth 58% 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 investigate a company's debt, in this case Luzhou LaojiaoLtd has CN¥19.9b in net cash and a decent-looking balance sheet. And we liked the look of last year's 28% year-on-year EBIT growth. So is Luzhou LaojiaoLtd's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Luzhou LaojiaoLtd that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com