Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We can see that China MeiDong Auto Holdings Limited (HKG: 1268) uses debt in his business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest analysis for China MeiDong Auto Holdings
What is the debt of China MeiDong Auto Holdings?
The image below, which you can click for more details, shows that China MeiDong Auto Holdings had a debt of CND 843.8 million at the end of June 2021, a reduction from CND 1.06 billion. CN over one year. But on the other hand, it also has CN 2.79 billion in cash, which leads to a net cash position of CN 1.94 billion.
A look at the liabilities of China MeiDong Auto Holdings
Zooming in on the latest balance sheet data, we can see that China MeiDong Auto Holdings had CN 3.06 billion in liabilities due within 12 months and CN in liabilities of 1.49 billion beyond. In compensation for these obligations, he had cash of CN 2.79 billion as well as receivables valued at CN 807.9 million due within 12 months. Thus, its liabilities total CN 954.9 million more than the combination of its cash and short-term receivables.
Considering that the listed shares of China MeiDong Auto Holdings are worth a total of CN ¥ 40.5b, it seems unlikely that this level of liabilities will be a major threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward. Despite its notable liabilities, China MeiDong Auto Holdings has a net cash position, so it is fair to say that it does not have a heavy debt load!
On top of that, China MeiDong Auto Holdings has increased its EBIT by 64% over the past twelve months, and this growth will make it easier to process its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether China MeiDong Auto Holdings can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. Although China MeiDong Auto Holdings has net cash on its balance sheet, it is still worth examining its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it is. this cash balance is built (or eroded). Over the past three years, China MeiDong Auto Holdings has produced strong free cash flow equivalent to 68% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
In summary
While it is always a good idea to look at a company’s total liabilities, it is very reassuring that China MeiDong Auto Holdings has 1.94 billion yen in net cash. And we liked the appearance of the 64% year-over-year growth in EBIT from last year. So is China MeiDong Auto Holdings’ debt a risk? It does not seem to us. On top of most other metrics, we think it’s important to track how quickly earnings per share are growing, if at all. If you also got this idea, you are in luck because today you can check out this interactive graph of historical earnings per share of China MeiDong Auto Holdings for free.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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