The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that CITIC Telecom International Holdings Limited (HKG:1883) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for CITIC Telecom International Holdings

What Is CITIC Telecom International Holdings's Debt?

As you can see below, CITIC Telecom International Holdings had HK$3.91b of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has HK$1.61b in cash leading to net debt of about HK$2.30b.

How Healthy Is CITIC Telecom International Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CITIC Telecom International Holdings had liabilities of HK$5.86b due within 12 months and liabilities of HK$764.0m due beyond that. Offsetting this, it had HK$1.61b in cash and HK$1.73b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$3.29b.

This deficit isn't so bad because CITIC Telecom International Holdings is worth HK$8.51b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

CITIC Telecom International Holdings has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 14.9 times over. So we're pretty relaxed about its super-conservative use of debt. It is just as well that CITIC Telecom International Holdings's load is not too heavy, because its EBIT was down 21% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CITIC Telecom International Holdings can strengthen its balance sheet over time. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, CITIC Telecom International Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Based on what we've seen CITIC Telecom International Holdings is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Considering this range of data points, we think CITIC Telecom International Holdings is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Given CITIC Telecom International Holdings has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.