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. Importantly, COSCO SHIPPING Holdings Co., Ltd. (HKG:1919) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 COSCO SHIPPING Holdings's Debt?
The chart below, which you can click on for greater detail, shows that COSCO SHIPPING Holdings had CN¥43.3b in debt in December 2023; about the same as the year before. But it also has CN¥182.4b in cash to offset that, meaning it has CN¥139.1b net cash.
How Healthy Is COSCO SHIPPING Holdings' Balance Sheet?
We can see from the most recent balance sheet that COSCO SHIPPING Holdings had liabilities of CN¥127.3b falling due within a year, and liabilities of CN¥91.9b due beyond that. On the other hand, it had cash of CN¥182.4b and CN¥10.6b worth of receivables due within a year. So its liabilities total CN¥26.2b more than the combination of its cash and short-term receivables.
Of course, COSCO SHIPPING Holdings has a titanic market capitalization of CN¥167.8b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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.
The modesty of its debt load may become crucial for COSCO SHIPPING Holdings if management cannot prevent a repeat of the 86% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if COSCO SHIPPING Holdings can strengthen its balance sheet over time. 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. While COSCO SHIPPING 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. 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 generation warms our hearts like a puppy in a bumblebee suit.
Summing Up
While COSCO SHIPPING Holdings does have more liabilities than liquid assets, it also has net cash of CN¥139.1b. The cherry on top was that in converted 115% of that EBIT to free cash flow, bringing in CN¥7.3b. So we are not troubled with COSCO SHIPPING Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for COSCO SHIPPING Holdings (2 are concerning) you should be aware of.
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.