Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies China Design Group Co., Ltd. (SHSE:603018) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does China Design Group Carry?
As you can see below, at the end of March 2024, China Design Group had CN¥484.6m of debt, up from CN¥259.3m a year ago. Click the image for more detail. But it also has CN¥1.89b in cash to offset that, meaning it has CN¥1.40b net cash.
How Healthy Is China Design Group's Balance Sheet?
According to the last reported balance sheet, China Design Group had liabilities of CN¥6.93b due within 12 months, and liabilities of CN¥453.3m due beyond 12 months. On the other hand, it had cash of CN¥1.89b and CN¥8.16b worth of receivables due within a year. So it can boast CN¥2.66b more liquid assets than total liabilities.
This surplus liquidity suggests that China Design Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, China Design Group boasts net cash, so it's fair to say it does not have a heavy debt load!
China Design Group's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China Design Group's ability to maintain a healthy balance sheet going forward. 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. China Design Group 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, China Design Group produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While it is always sensible to investigate a company's debt, in this case China Design Group has CN¥1.40b in net cash and a decent-looking balance sheet. So is China Design Group's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for China Design Group that you should be aware of before investing here.
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.
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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.