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. Importantly, Chuzhou Duoli Automotive Technology Co., Ltd. (SZSE:001311) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Chuzhou Duoli Automotive Technology's Debt?
The image below, which you can click on for greater detail, shows that Chuzhou Duoli Automotive Technology had debt of CN¥111.6m at the end of September 2023, a reduction from CN¥625.0m over a year. But on the other hand it also has CN¥1.26b in cash, leading to a CN¥1.15b net cash position.
How Strong Is Chuzhou Duoli Automotive Technology's Balance Sheet?
According to the last reported balance sheet, Chuzhou Duoli Automotive Technology had liabilities of CN¥960.8m due within 12 months, and liabilities of CN¥115.1m due beyond 12 months. On the other hand, it had cash of CN¥1.26b and CN¥1.30b worth of receivables due within a year. So it actually has CN¥1.49b more liquid assets than total liabilities.
This surplus suggests that Chuzhou Duoli Automotive Technology is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Chuzhou Duoli Automotive Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Chuzhou Duoli Automotive Technology grew its EBIT by 13% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Chuzhou Duoli Automotive Technology 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. While Chuzhou Duoli Automotive Technology 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, Chuzhou Duoli Automotive Technology 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 it is always sensible to investigate a company's debt, in this case Chuzhou Duoli Automotive Technology has CN¥1.15b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 13% over the last year. So we are not troubled with Chuzhou Duoli Automotive Technology's debt use. 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. For example Chuzhou Duoli Automotive Technology has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.