Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that 361 Degrees International Limited (HKG:1361) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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.
See our latest analysis for 361 Degrees International
How Much Debt Does 361 Degrees International Carry?
The chart below, which you can click on for greater detail, shows that 361 Degrees International had CN¥2.75b in debt in June 2019; about the same as the year before. However, it does have CN¥6.12b in cash offsetting this, leading to net cash of CN¥3.37b.
How Strong Is 361 Degrees International's Balance Sheet?
The latest balance sheet data shows that 361 Degrees International had liabilities of CN¥3.41b due within a year, and liabilities of CN¥2.65b falling due after that. Offsetting these obligations, it had cash of CN¥6.12b as well as receivables valued at CN¥3.09b due within 12 months. So it can boast CN¥3.16b more liquid assets than total liabilities.
This surplus liquidity suggests that 361 Degrees International's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that 361 Degrees International has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, 361 Degrees International's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine 361 Degrees International's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 361 Degrees International 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 most recent three years, 361 Degrees International recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case 361 Degrees International has CN¥3.37b in net cash and a strong balance sheet. And it impressed us with free cash flow of CN¥294m, being 70% of its EBIT. So is 361 Degrees International's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in 361 Degrees International 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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