Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Zhuzhou CRRC Times Electric Co., Ltd. (HKG:3898) does carry debt. But should shareholders be worried about its use of debt?
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. If things get really bad, the lenders can take control of the business. 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. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Zhuzhou CRRC Times Electric's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2023 Zhuzhou CRRC Times Electric had CN¥1.12b of debt, an increase on CN¥551.1m, over one year. But on the other hand it also has CN¥13.8b in cash, leading to a CN¥12.7b net cash position.
A Look At Zhuzhou CRRC Times Electric's Liabilities
Zooming in on the latest balance sheet data, we can see that Zhuzhou CRRC Times Electric had liabilities of CN¥13.4b due within 12 months and liabilities of CN¥2.26b due beyond that. On the other hand, it had cash of CN¥13.8b and CN¥17.1b worth of receivables due within a year. So it can boast CN¥15.3b more liquid assets than total liabilities.
This surplus suggests that Zhuzhou CRRC Times Electric 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, Zhuzhou CRRC Times Electric boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Zhuzhou CRRC Times Electric grew its EBIT by 17% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhuzhou CRRC Times Electric'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Zhuzhou CRRC Times Electric 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. In the last three years, Zhuzhou CRRC Times Electric's free cash flow amounted to 31% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Zhuzhou CRRC Times Electric has net cash of CN¥12.7b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 17% over the last year. So is Zhuzhou CRRC Times Electric's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Zhuzhou CRRC Times Electric's earnings per share history for free.
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.