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 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. Importantly, Newland Digital Technology Co.,Ltd. (SZSE:000997) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Newland Digital TechnologyLtd Carry?
As you can see below, at the end of March 2024, Newland Digital TechnologyLtd had CN¥1.05b of debt, up from CN¥768.3m a year ago. Click the image for more detail. However, it does have CN¥3.35b in cash offsetting this, leading to net cash of CN¥2.30b.
How Strong Is Newland Digital TechnologyLtd's Balance Sheet?
According to the last reported balance sheet, Newland Digital TechnologyLtd had liabilities of CN¥5.11b due within 12 months, and liabilities of CN¥159.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.35b as well as receivables valued at CN¥2.38b due within 12 months. So it actually has CN¥469.2m more liquid assets than total liabilities.
This surplus suggests that Newland Digital TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Newland Digital TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Newland Digital TechnologyLtd grew its EBIT by 163% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Newland Digital TechnologyLtd 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Newland Digital TechnologyLtd 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. Over the last three years, Newland Digital TechnologyLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Newland Digital TechnologyLtd has net cash of CN¥2.30b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥1.2b, being 149% of its EBIT. So is Newland Digital TechnologyLtd's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Newland Digital TechnologyLtd .
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.
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.