Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that China Resources Cement Holdings Limited (HKG:1313) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for China Resources Cement Holdings

How Much Debt Does China Resources Cement Holdings Carry?

As you can see below, China Resources Cement Holdings had HK$11.3b of debt at June 2019, down from HK$15.6b a year prior. On the flip side, it has HK$8.80b in cash leading to net debt of about HK$2.54b.

A Look At China Resources Cement Holdings's Liabilities

Zooming in on the latest balance sheet data, we can see that China Resources Cement Holdings had liabilities of HK$9.58b due within 12 months and liabilities of HK$10.9b due beyond that. Offsetting this, it had HK$8.80b in cash and HK$6.55b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$5.14b.

Given China Resources Cement Holdings has a market capitalization of HK$57.8b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

China Resources Cement Holdings has a low net debt to EBITDA ratio of only 0.20. And its EBIT covers its interest expense a whopping 29.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that China Resources Cement Holdings has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Resources Cement Holdings 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, China Resources Cement Holdings generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

China Resources Cement Holdings's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. We think China Resources Cement Holdings is no more beholden to its lenders, than the birds are to birdwatchers. To our minds it has a healthy happy balance sheet. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check China Resources Cement Holdings's dividend history, without delay!

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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. Thank you for reading.