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.' 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 can see that Haidilao International Holding Ltd. (HKG:6862) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Haidilao International Holding Carry?
The image below, which you can click on for greater detail, shows that Haidilao International Holding had debt of CN¥2.76b at the end of December 2023, a reduction from CN¥4.68b over a year. However, it does have CN¥11.4b in cash offsetting this, leading to net cash of CN¥8.61b.
How Strong Is Haidilao International Holding's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Haidilao International Holding had liabilities of CN¥7.24b due within 12 months and liabilities of CN¥5.92b due beyond that. Offsetting this, it had CN¥11.4b in cash and CN¥1.42b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥380.0m.
Having regard to Haidilao International Holding's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥88.6b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Haidilao International Holding boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, Haidilao International Holding grew its EBIT by 168% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Haidilao International Holding'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, a company can only pay off debt with cold hard cash, not accounting profits. Haidilao International Holding 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. During the last three years, Haidilao International Holding produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
We could understand if investors are concerned about Haidilao International Holding's liabilities, but we can be reassured by the fact it has has net cash of CN¥8.61b. And we liked the look of last year's 168% year-on-year EBIT growth. So is Haidilao International Holding's debt a risk? It doesn't seem so to us. 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 example, we've discovered 1 warning sign for Haidilao International Holding 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.