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. As with many other companies Ningbo Fuda Company Limited (SHSE:600724) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Ningbo Fuda
What Is Ningbo Fuda's Debt?
As you can see below, at the end of June 2023, Ningbo Fuda had CN¥557.2m of debt, up from CN¥191.2m a year ago. Click the image for more detail. But it also has CN¥1.22b in cash to offset that, meaning it has CN¥662.6m net cash.
A Look At Ningbo Fuda's Liabilities
According to the last reported balance sheet, Ningbo Fuda had liabilities of CN¥922.3m due within 12 months, and liabilities of CN¥138.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.22b as well as receivables valued at CN¥526.5m due within 12 months. So it actually has CN¥685.3m more liquid assets than total liabilities.
This surplus suggests that Ningbo Fuda has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ningbo Fuda has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for Ningbo Fuda if management cannot prevent a repeat of the 35% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ningbo Fuda's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Ningbo Fuda has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Ningbo Fuda's free cash flow amounted to 36% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Ningbo Fuda has net cash of CN¥662.6m, as well as more liquid assets than liabilities. So we are not troubled with Ningbo Fuda's debt use. 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 Ningbo Fuda has 3 warning signs (and 2 which don't sit too well with us) we think you should know about.
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.
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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.
