Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that China XD Electric Co., Ltd (SHSE:601179) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does China XD Electric Carry?
The image below, which you can click on for greater detail, shows that at March 2024 China XD Electric had debt of CN¥1.26b, up from CN¥804.0m in one year. But it also has CN¥10.3b in cash to offset that, meaning it has CN¥9.06b net cash.
How Strong Is China XD Electric's Balance Sheet?
The latest balance sheet data shows that China XD Electric had liabilities of CN¥17.1b due within a year, and liabilities of CN¥1.88b falling due after that. On the other hand, it had cash of CN¥10.3b and CN¥13.6b worth of receivables due within a year. So it can boast CN¥4.94b more liquid assets than total liabilities.
This surplus suggests that China XD Electric has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that China XD Electric has more cash than debt is arguably a good indication that it can manage its debt safely.
Better yet, China XD Electric grew its EBIT by 116% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China XD Electric'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China XD Electric 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. Happily for any shareholders, China XD Electric actually produced more free cash flow than EBIT over the last three years. 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 China XD Electric has net cash of CN¥9.06b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.7b, being 140% of its EBIT. So is China XD Electric'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. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with China XD Electric .
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com