China Mengniu Dairy (HKG: 2319) Seems to Use Debt Quite Wisely
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We notice that China Mengniu Dairy Company Limited (HKG: 2319) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first look at cash and debt levels, together.
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What is the net debt of China Mengniu Dairy?
You can click on the graph below for historical figures, but it shows that China Mengniu Dairy had CN 23.0 billion debt in June 2021, up from CN Â¥ 29.2 billion a year earlier. However, it has CNN 13.7 billion in cash offsetting this, leading to net debt of around CNN 9.34 billion.
How healthy is China Mengniu Dairy’s balance sheet?
Zooming in on the latest balance sheet data, we can see that China Mengniu Dairy had CN 27.6 billion liabilities due within 12 months and CN 19.1 billion liabilities beyond. On the other hand, he had CN 13.7 billion in cash and CN 4.67 billion in receivables due within one year. It therefore has liabilities totaling CNN 28.4 billion more than its cash and short-term receivables combined.
Considering that China Mengniu Dairy has a huge market cap of CN Â¥ 147.4b, it’s hard to believe that these liabilities pose a big threat. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
We would say that China Mengniu Dairy’s moderate net debt to EBITDA ratio (at 1.6) indicates debt cautiousness. And its EBIT of 1,000 times its interest costs, means the debt load is as light as a peacock feather. On top of that, we are happy to report that China Mengniu Dairy has increased its EBIT by 64%, reducing the specter of future debt repayments. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether China Mengniu Dairy can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. In the past three years, China Mengniu Dairy has reported free cash flow of 8.9% of its EBIT, which is really quite low. This low level of cash conversion undermines its ability to manage and repay its debts.
Our point of view
Fortunately, China Mengniu Dairy’s impressive interest coverage means it has the upper hand on its debt. But we have to admit that its conversion from EBIT to free cash flow has the opposite effect. All these things considered, it looks like China Mengniu Dairy can comfortably manage its current level of debt. On the plus side, this leverage can increase returns to shareholders, but the potential downside is more risk of loss, so it’s worth watching the balance sheet. On top of most other metrics, we think it’s important to track how quickly earnings per share are growing, if at all. If you also understood this, you are in luck because today you can check this interactive historical earnings per share chart of China Mengniu Dairy for free.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow-growing stocks.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.