Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Suzhou Xianglou New Material Co., Ltd. (SZSE:301160) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
How Much Debt Does Suzhou Xianglou New Material Carry?
The image below, which you can click on for greater detail, shows that at September 2024 Suzhou Xianglou New Material had debt of CN¥109.3m, up from CN¥94.6m in one year. However, its balance sheet shows it holds CN¥268.9m in cash, so it actually has CN¥159.6m net cash.
A Look At Suzhou Xianglou New Material's Liabilities
We can see from the most recent balance sheet that Suzhou Xianglou New Material had liabilities of CN¥270.7m falling due within a year, and liabilities of CN¥36.3m due beyond that. Offsetting these obligations, it had cash of CN¥268.9m as well as receivables valued at CN¥472.8m due within 12 months. So it can boast CN¥434.7m more liquid assets than total liabilities.
This surplus suggests that Suzhou Xianglou New Material has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Suzhou Xianglou New Material boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Suzhou Xianglou New Material grew its EBIT at 16% over the last year, further increasing its ability to manage 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 Suzhou Xianglou New Material's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. Suzhou Xianglou New Material 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. Considering the last three years, Suzhou Xianglou New Material actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
Summing Up
While it is always sensible to investigate a company's debt, in this case Suzhou Xianglou New Material has CN¥159.6m in net cash and a decent-looking balance sheet. And we liked the look of last year's 16% year-on-year EBIT growth. So we don't have any problem with Suzhou Xianglou New Material's use of debt. 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. Case in point: We've spotted 4 warning signs for Suzhou Xianglou New Material you should be aware of, and 1 of them makes us a bit uncomfortable.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
