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.' 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 COSCO SHIPPING Holdings Co., Ltd. (HKG:1919) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for COSCO SHIPPING Holdings
How Much Debt Does COSCO SHIPPING Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that COSCO SHIPPING Holdings had CN¥52.1b of debt in September 2023, down from CN¥66.9b, one year before. However, it does have CN¥199.1b in cash offsetting this, leading to net cash of CN¥146.9b.
How Healthy Is COSCO SHIPPING Holdings' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that COSCO SHIPPING Holdings had liabilities of CN¥134.1b due within 12 months and liabilities of CN¥94.4b due beyond that. On the other hand, it had cash of CN¥199.1b and CN¥11.0b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥18.4b.
Of course, COSCO SHIPPING Holdings has a titanic market capitalization of CN¥144.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, COSCO SHIPPING Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.
It is just as well that COSCO SHIPPING Holdings's load is not too heavy, because its EBIT was down 72% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 COSCO SHIPPING Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. COSCO SHIPPING Holdings 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. Happily for any shareholders, COSCO SHIPPING Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing Up
While COSCO SHIPPING Holdings does have more liabilities than liquid assets, it also has net cash of CN¥146.9b. The cherry on top was that in converted 119% of that EBIT to free cash flow, bringing in CN¥34b. So we are not troubled with COSCO SHIPPING Holdings's debt use. 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. For example, we've discovered 3 warning signs for COSCO SHIPPING Holdings (1 shouldn't be ignored!) that you should be aware of before investing here.
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.