The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Nongfu Spring Co., Ltd. (HKG:9633) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Nongfu Spring's Net Debt?

As you can see below, Nongfu Spring had CN¥3.86b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥19.0b in cash to offset that, meaning it has CN¥15.2b net cash.

How Strong Is Nongfu Spring's Balance Sheet?

We can see from the most recent balance sheet that Nongfu Spring had liabilities of CN¥29.0b falling due within a year, and liabilities of CN¥671.2m due beyond that. On the other hand, it had cash of CN¥19.0b and CN¥703.2m worth of receivables due within a year. So its liabilities total CN¥9.93b more than the combination of its cash and short-term receivables.

Given Nongfu Spring has a humongous market capitalization of CN¥378.8b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Nongfu Spring boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Nongfu Spring has boosted its EBIT by 34%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Nongfu Spring 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Nongfu Spring 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, Nongfu Spring recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Nongfu Spring's liabilities, but we can be reassured by the fact it has has net cash of CN¥15.2b. And we liked the look of last year's 34% year-on-year EBIT growth. So is Nongfu Spring'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. Be aware that Nongfu Spring is showing 1 warning sign in our investment analysis , you should know about...

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.