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.' 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. As with many other companies Jiangxi Special Electric Motor Co.,Ltd (SZSE:002176) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Jiangxi Special Electric MotorLtd's Debt?
As you can see below, at the end of March 2024, Jiangxi Special Electric MotorLtd had CN¥1.29b of debt, up from CN¥587.9m a year ago. Click the image for more detail. On the flip side, it has CN¥811.1m in cash leading to net debt of about CN¥474.3m.
How Healthy Is Jiangxi Special Electric MotorLtd's Balance Sheet?
According to the last reported balance sheet, Jiangxi Special Electric MotorLtd had liabilities of CN¥2.11b due within 12 months, and liabilities of CN¥850.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥811.1m as well as receivables valued at CN¥1.26b due within 12 months. So it has liabilities totalling CN¥891.9m more than its cash and near-term receivables, combined.
Of course, Jiangxi Special Electric MotorLtd has a market capitalization of CN¥16.5b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Jiangxi Special Electric MotorLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Jiangxi Special Electric MotorLtd made a loss at the EBIT level, and saw its revenue drop to CN¥2.4b, which is a fall of 59%. That makes us nervous, to say the least.
Caveat Emptor
Not only did Jiangxi Special Electric MotorLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥423m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of CN¥478m into a profit. So to be blunt we do think it is risky. For riskier companies like Jiangxi Special Electric MotorLtd I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
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.