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 Uni-President China Holdings Ltd (HKG:220) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Uni-President China Holdings
What Is Uni-President China Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that Uni-President China Holdings had debt of CN¥2.60b at the end of June 2023, a reduction from CN¥2.74b over a year. But it also has CN¥3.31b in cash to offset that, meaning it has CN¥706.7m net cash.
How Healthy Is Uni-President China Holdings' Balance Sheet?
According to the last reported balance sheet, Uni-President China Holdings had liabilities of CN¥8.89b due within 12 months, and liabilities of CN¥763.4m due beyond 12 months. On the other hand, it had cash of CN¥3.31b and CN¥682.3m worth of receivables due within a year. So it has liabilities totalling CN¥5.66b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Uni-President China Holdings has a market capitalization of CN¥20.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Uni-President China Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Another good sign is that Uni-President China Holdings has been able to increase its EBIT by 20% 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 it is future earnings, more than anything, that will determine Uni-President China Holdings'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Uni-President China Holdings 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, Uni-President China Holdings 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
While Uni-President China Holdings does have more liabilities than liquid assets, it also has net cash of CN¥706.7m. The cherry on top was that in converted 108% of that EBIT to free cash flow, bringing in CN¥1.4b. So we don't think Uni-President China Holdings's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. 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 Uni-President China Holdings .
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.