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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Jiangsu Rainbow Heavy Industries Co., Ltd. (SZSE:002483) makes use of debt. 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Jiangsu Rainbow Heavy Industries's Debt?
As you can see below, Jiangsu Rainbow Heavy Industries had CN¥959.0m of debt at December 2023, down from CN¥1.22b a year prior. But on the other hand it also has CN¥3.52b in cash, leading to a CN¥2.56b net cash position.
A Look At Jiangsu Rainbow Heavy Industries' Liabilities
According to the last reported balance sheet, Jiangsu Rainbow Heavy Industries had liabilities of CN¥5.88b due within 12 months, and liabilities of CN¥563.9m due beyond 12 months. On the other hand, it had cash of CN¥3.52b and CN¥1.89b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.03b.
While this might seem like a lot, it is not so bad since Jiangsu Rainbow Heavy Industries has a market capitalization of CN¥4.51b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Jiangsu Rainbow Heavy Industries boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Jiangsu Rainbow Heavy Industries has boosted its EBIT by 97%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Jiangsu Rainbow Heavy Industries can strengthen its balance sheet over time. 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. Jiangsu Rainbow Heavy Industries 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. Happily for any shareholders, Jiangsu Rainbow Heavy Industries actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing Up
Although Jiangsu Rainbow Heavy Industries's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥2.56b. The cherry on top was that in converted 176% of that EBIT to free cash flow, bringing in CN¥845m. So we don't think Jiangsu Rainbow Heavy Industries's use of debt is risky. 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 - Jiangsu Rainbow Heavy Industries has 2 warning signs we think you should be aware of.
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.