Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Nongfu Spring Co., Ltd. (HKG:9633) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Nongfu Spring's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Nongfu Spring had CN¥3.12b of debt, an increase on CN¥2.43b, over one year. However, its balance sheet shows it holds CN¥24.2b in cash, so it actually has CN¥21.1b net cash.

How Healthy Is Nongfu Spring's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Nongfu Spring had liabilities of CN¥19.9b due within 12 months and liabilities of CN¥689.7m due beyond that. Offsetting these obligations, it had cash of CN¥24.2b as well as receivables valued at CN¥670.9m due within 12 months. So it actually has CN¥4.34b more liquid assets than total liabilities.

This state of affairs indicates that Nongfu Spring's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥486.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Nongfu Spring has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Nongfu Spring grew its EBIT by 48% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Nongfu Spring 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Nongfu Spring 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, Nongfu Spring recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Nongfu Spring has CN¥21.1b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in CN¥13b. So is Nongfu Spring's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Nongfu Spring would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.