Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that Changzhou Almaden Co., Ltd. (SZSE:002623) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Changzhou Almaden's Debt?
As you can see below, at the end of September 2023, Changzhou Almaden had CN¥912.6m of debt, up from CN¥548.4m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.67b in cash, leading to a CN¥752.5m net cash position.
A Look At Changzhou Almaden's Liabilities
According to the last reported balance sheet, Changzhou Almaden had liabilities of CN¥1.71b due within 12 months, and liabilities of CN¥533.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.67b as well as receivables valued at CN¥1.46b due within 12 months. So it actually has CN¥882.3m more liquid assets than total liabilities.
This excess liquidity suggests that Changzhou Almaden is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Changzhou Almaden boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Changzhou Almaden grew its EBIT by 106% over twelve months. 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 Changzhou Almaden'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Changzhou Almaden 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, Changzhou Almaden burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing Up
While it is always sensible to investigate a company's debt, in this case Changzhou Almaden has CN¥752.5m in net cash and a decent-looking balance sheet. And we liked the look of last year's 106% year-on-year EBIT growth. So is Changzhou Almaden'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. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Changzhou Almaden you should know about.
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.
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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.
