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.' 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. We note that CMST Development Co.,Ltd. (SHSE:600787) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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 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 think about a company's use of debt, we first look at cash and debt together.
What Is CMST DevelopmentLtd's Debt?
You can click the graphic below for the historical numbers, but it shows that CMST DevelopmentLtd had CN¥2.49b of debt in December 2023, down from CN¥3.55b, one year before. However, its balance sheet shows it holds CN¥3.22b in cash, so it actually has CN¥724.8m net cash.
A Look At CMST DevelopmentLtd's Liabilities
We can see from the most recent balance sheet that CMST DevelopmentLtd had liabilities of CN¥5.16b falling due within a year, and liabilities of CN¥3.03b due beyond that. On the other hand, it had cash of CN¥3.22b and CN¥4.61b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥364.8m.
Of course, CMST DevelopmentLtd has a market capitalization of CN¥11.1b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, CMST DevelopmentLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, CMST DevelopmentLtd grew its EBIT by 75% 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 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While CMST DevelopmentLtd 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. Over the last three years, CMST DevelopmentLtd actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing Up
While it is always sensible to look at a company's total liabilities, it is very reassuring that CMST DevelopmentLtd has CN¥724.8m in net cash. The cherry on top was that in converted 196% of that EBIT to free cash flow, bringing in CN¥723m. So we don't think CMST DevelopmentLtd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for CMST DevelopmentLtd that you should be aware of before investing here.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.