Is Dongwu Cement International (HKG:695) A Risky Investment?
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk'. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Dongwu Cement International Limited (HKG:695) makes use of debt. But the real question is whether this debt is making the company risky.
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Dongwu Cement International
What Is Dongwu Cement International's Debt?
As you can see below, Dongwu Cement International had CN¥37.0m of debt at December 2019, down from CN¥71.6m a year prior. But on the other hand it also has CN¥131.0m in cash, leading to a CN¥94.0m net cash position.
A Look At Dongwu Cement International's Liabilities
We can see from the most recent balance sheet that Dongwu Cement International had liabilities of CN¥250.8m falling due within a year, and liabilities of CN¥26.6m due beyond that. On the other hand, it had cash of CN¥131.0m and CN¥248.6m worth of receivables due within a year. So it actually has CN¥102.2m more liquid assets than total liabilities.
This short term liquidity is a sign that Dongwu Cement International could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Dongwu Cement International has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, Dongwu Cement International's EBIT dived 16%, 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 Dongwu Cement International's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Dongwu Cement 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. During the last three years, Dongwu Cement International generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Summing up
While it is always sensible to investigate a company's debt, in this case Dongwu Cement International has CN¥94.0m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in CN¥176m. So we don't think Dongwu Cement International's use of debt is risky. We'd be motivated to research the stock further if we found out that Dongwu Cement International insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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