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.' 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 note that China Spacesat Co.,Ltd. (SHSE:600118) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is China SpacesatLtd's Net Debt?
As you can see below, at the end of September 2023, China SpacesatLtd had CN¥187.4m of debt, up from CN¥178.2m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.79b in cash, so it actually has CN¥2.60b net cash.
A Look At China SpacesatLtd's Liabilities
According to the last reported balance sheet, China SpacesatLtd had liabilities of CN¥6.23b due within 12 months, and liabilities of CN¥388.0m due beyond 12 months. On the other hand, it had cash of CN¥2.79b and CN¥5.72b worth of receivables due within a year. So it actually has CN¥1.90b more liquid assets than total liabilities.
This short term liquidity is a sign that China SpacesatLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that China SpacesatLtd has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that China SpacesatLtd's load is not too heavy, because its EBIT was down 47% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China SpacesatLtd'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. China SpacesatLtd 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, China SpacesatLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that China SpacesatLtd has net cash of CN¥2.60b, as well as more liquid assets than liabilities. So we don't have any problem with China SpacesatLtd'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. For example - China SpacesatLtd has 2 warning signs we think you should be aware of.
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.