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China Communications Services (HKG:552) Seems To Use Debt Quite Sensibly

Simply Wall St ·  Aug 30, 2022 03:05

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that China Communications Services Corporation Limited (HKG:552) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for China Communications Services

How Much Debt Does China Communications Services Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 China Communications Services had CN¥850.0m of debt, an increase on CN¥764.9m, over one year. But on the other hand it also has CN¥19.5b in cash, leading to a CN¥18.6b net cash position.

debt-equity-history-analysisSEHK:552 Debt to Equity History August 30th 2022

A Look At China Communications Services' Liabilities

The latest balance sheet data shows that China Communications Services had liabilities of CN¥64.2b due within a year, and liabilities of CN¥2.30b falling due after that. Offsetting these obligations, it had cash of CN¥19.5b as well as receivables valued at CN¥47.8b due within 12 months. So these liquid assets roughly match the total liabilities.

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

The modesty of its debt load may become crucial for China Communications Services if management cannot prevent a repeat of the 44% cut to EBIT 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 it is future earnings, more than anything, that will determine China Communications Services'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China Communications Services 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, China Communications Services actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Communications Services has net cash of CN¥18.6b, as well as more liquid assets than liabilities. The cherry on top was that in converted 108% of that EBIT to free cash flow, bringing in CN¥2.7b. So we are not troubled with China Communications Services's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with China Communications Services .

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.

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

Disclaimer: This content is for informational and educational purposes only and does not constitute a recommendation or endorsement of any specific investment or investment strategy. Read more
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