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. As with many other companies Dajin Heavy Industry Co.,Ltd. (SZSE:002487) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Dajin Heavy IndustryLtd's Debt?
The image below, which you can click on for greater detail, shows that Dajin Heavy IndustryLtd had debt of CN¥74.4m at the end of March 2024, a reduction from CN¥693.3m over a year. But it also has CN¥2.32b in cash to offset that, meaning it has CN¥2.25b net cash.
How Strong Is Dajin Heavy IndustryLtd's Balance Sheet?
We can see from the most recent balance sheet that Dajin Heavy IndustryLtd had liabilities of CN¥2.68b falling due within a year, and liabilities of CN¥378.1m due beyond that. Offsetting these obligations, it had cash of CN¥2.32b as well as receivables valued at CN¥2.24b due within 12 months. So it can boast CN¥1.51b more liquid assets than total liabilities.
This short term liquidity is a sign that Dajin Heavy IndustryLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Dajin Heavy IndustryLtd has more cash than debt is arguably a good indication that it can manage its debt safely.
And we also note warmly that Dajin Heavy IndustryLtd grew its EBIT by 11% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dajin Heavy IndustryLtd'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 company can only pay off debt with cold hard cash, not accounting profits. While Dajin Heavy IndustryLtd 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. During the last three years, Dajin Heavy IndustryLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Dajin Heavy IndustryLtd has net cash of CN¥2.25b, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 11% in the last twelve months. So we don't have any problem with Dajin Heavy IndustryLtd's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Dajin Heavy IndustryLtd is showing 1 warning sign in our investment analysis , 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.
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