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 can see that Jiangsu Phoenix Publishing & Media Corporation Limited (SHSE:601928) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Jiangsu Phoenix Publishing & Media's Debt?
As you can see below, Jiangsu Phoenix Publishing & Media had CN¥161.4m of debt at December 2023, down from CN¥176.2m a year prior. But it also has CN¥3.14b in cash to offset that, meaning it has CN¥2.98b net cash.
How Healthy Is Jiangsu Phoenix Publishing & Media's Balance Sheet?
According to the last reported balance sheet, Jiangsu Phoenix Publishing & Media had liabilities of CN¥10.6b due within 12 months, and liabilities of CN¥1.33b due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.14b as well as receivables valued at CN¥748.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥8.03b.
While this might seem like a lot, it is not so bad since Jiangsu Phoenix Publishing & Media has a market capitalization of CN¥26.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Jiangsu Phoenix Publishing & Media also has more cash than debt, so we're pretty confident it can manage its debt safely.
Also positive, Jiangsu Phoenix Publishing & Media grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Jiangsu Phoenix Publishing & Media 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. Jiangsu Phoenix Publishing & Media 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. Happily for any shareholders, Jiangsu Phoenix Publishing & Media 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 Jiangsu Phoenix Publishing & Media does have more liabilities than liquid assets, it also has net cash of CN¥2.98b. And it impressed us with free cash flow of CN¥2.1b, being 137% of its EBIT. So is Jiangsu Phoenix Publishing & Media's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Jiangsu Phoenix Publishing & Media (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.
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.