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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, CMST Development Co.,Ltd. (SHSE:600787) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for CMST DevelopmentLtd
How Much Debt Does CMST DevelopmentLtd Carry?
You can click the graphic below for the historical numbers, but it shows that CMST DevelopmentLtd had CN¥2.95b of debt in September 2023, down from CN¥3.75b, one year before. But on the other hand it also has CN¥3.32b in cash, leading to a CN¥364.5m net cash position.
How Healthy Is CMST DevelopmentLtd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that CMST DevelopmentLtd had liabilities of CN¥6.52b due within 12 months and liabilities of CN¥3.47b due beyond that. On the other hand, it had cash of CN¥3.32b and CN¥4.82b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.86b.
Of course, CMST DevelopmentLtd has a market capitalization of CN¥10.5b, 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. Despite its noteworthy liabilities, CMST DevelopmentLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for CMST DevelopmentLtd if management cannot prevent a repeat of the 26% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since CMST DevelopmentLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. CMST DevelopmentLtd 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, CMST DevelopmentLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
While CMST DevelopmentLtd does have more liabilities than liquid assets, it also has net cash of CN¥364.5m. And it impressed us with free cash flow of CN¥927m, being 294% of its EBIT. So we are not troubled with CMST DevelopmentLtd'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. Case in point: We've spotted 2 warning signs for CMST DevelopmentLtd you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.