Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Jiuzhitang Co., Ltd. (SZSE:000989) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.
How Much Debt Does Jiuzhitang Carry?
The image below, which you can click on for greater detail, shows that at June 2024 Jiuzhitang had debt of CN¥288.4m, up from CN¥200.8m in one year. However, it does have CN¥522.2m in cash offsetting this, leading to net cash of CN¥233.9m.
How Healthy Is Jiuzhitang's Balance Sheet?
The latest balance sheet data shows that Jiuzhitang had liabilities of CN¥1.73b due within a year, and liabilities of CN¥96.2m falling due after that. Offsetting these obligations, it had cash of CN¥522.2m as well as receivables valued at CN¥1.66b due within 12 months. So it actually has CN¥359.6m more liquid assets than total liabilities.
This short term liquidity is a sign that Jiuzhitang could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Jiuzhitang boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Jiuzhitang's load is not too heavy, because its EBIT was down 32% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Jiuzhitang will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Jiuzhitang 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 last three years, Jiuzhitang reported free cash flow worth 19% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Summing Up
While it is always sensible to investigate a company's debt, in this case Jiuzhitang has CN¥233.9m in net cash and a decent-looking balance sheet. So we don't have any problem with Jiuzhitang's use of debt. 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 Jiuzhitang that you should be aware of.
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.
