Chow Tai Seng Jewellery Co., Ltd. (SZSE:002867) has maintained a healthy balance sheet despite using debt in its business operations. This analysis delves into the extent of the risk posed by this debt.
Understanding Debt Risks
Debt becomes problematic for a business if it cannot meet its obligations through free cash flow or by raising capital at favorable terms. Failure to repay debt can result in shareholders losing their investments. Though not common, indebted companies might dilute shareholder value to satisfy lender demands. However, debt can be advantageous as it often represents inexpensive capital compared to equity dilution. To assess the risk, it’s crucial to examine a company’s cash and debt levels together.
Chow Tai Seng Jewellery’s Debt Position
As of March 2024, Chow Tai Seng Jewellery had CN¥881.8 million in debt, an increase from CN¥418.3 million the previous year. However, with CN¥1.88 billion in cash reserves, the company effectively has CN¥999.6 million in net cash.
Assessing the Balance Sheet Health
The latest balance sheet shows Chow Tai Seng Jewellery with CN¥2.33 billion in liabilities due within a year and CN¥56.4 million in long-term liabilities. On the asset side, it holds CN¥1.88 billion in cash and CN¥1.10 billion in receivables due within a year. This results in a CN¥593.2 million surplus in liquid assets over total liabilities, indicating a strong and conservative balance sheet. The company’s net cash position suggests it can comfortably manage its debt load.
Moreover, the company’s EBIT grew by 15% over the past year, enhancing its capacity to handle debt. While the balance sheet is a critical starting point for assessing debt levels, future earnings will play a vital role in maintaining this health.
Cash Flow Analysis
Although Chow Tai Seng Jewellery has a net cash position, it’s essential to consider its cash flow efficiency. Over the past three years, the company converted only 34% of its EBIT to free cash flow, which is lower than expected. This weak cash conversion could complicate debt management.
Conclusion
Chow Tai Seng Jewellery appears to be in a strong financial position with CN¥999.6 million in net cash and a solid balance sheet. Despite the weaker cash conversion rate, the company’s 15% EBIT growth over the past year reduces the perceived risk from its debt. However, investors should remain aware of potential risks beyond the balance sheet, such as the two warning signs associated with the company.
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