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 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. We note that C&S Paper Co.,Ltd (SZSE:002511) does have debt on its balance sheet. 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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does C&S PaperLtd Carry?
As you can see below, at the end of March 2024, C&S PaperLtd had CN¥1.62b of debt, up from CN¥1.19b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.95b in cash, so it actually has CN¥1.33b net cash.
How Strong Is C&S PaperLtd's Balance Sheet?
According to the last reported balance sheet, C&S PaperLtd had liabilities of CN¥4.02b due within 12 months, and liabilities of CN¥234.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.95b as well as receivables valued at CN¥1.10b due within 12 months. So it has liabilities totalling CN¥198.8m more than its cash and near-term receivables, combined.
Since publicly traded C&S PaperLtd shares are worth a total of CN¥9.21b, 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, C&S PaperLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that C&S PaperLtd saw its EBIT decline by 2.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine C&S PaperLtd'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 C&S PaperLtd 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 last three years, C&S PaperLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
We could understand if investors are concerned about C&S PaperLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥1.33b. And it impressed us with free cash flow of CN¥411m, being 103% of its EBIT. So is C&S PaperLtd's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with C&S PaperLtd .
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.