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. We can see that Xtep International Holdings Limited (HKG:1368) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Xtep International Holdings's Debt?
As you can see below, at the end of December 2023, Xtep International Holdings had CN¥3.60b of debt, up from CN¥3.32b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥3.29b, its net debt is less, at about CN¥304.3m.
How Strong Is Xtep International Holdings' Balance Sheet?
The latest balance sheet data shows that Xtep International Holdings had liabilities of CN¥5.85b due within a year, and liabilities of CN¥2.55b falling due after that. Offsetting this, it had CN¥3.29b in cash and CN¥4.98b in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This state of affairs indicates that Xtep International Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥13.1b company is short on cash, but still worth keeping an eye on the balance sheet.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Xtep International Holdings's net debt is only 0.18 times its EBITDA. And its EBIT covers its interest expense a whopping 20.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that Xtep International Holdings has increased its EBIT by 6.5% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Xtep International Holdings'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. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Xtep International Holdings's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Our View
Xtep International Holdings's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Taking all this data into account, it seems to us that Xtep International Holdings takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Xtep International Holdings you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.