We Think Changchun Engley Automobile IndustryLtd (SHSE:601279) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Changchun Engley Automobile Industry Co.,Ltd. (SHSE:601279) does use debt in its business. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Changchun Engley Automobile IndustryLtd

How Much Debt Does Changchun Engley Automobile IndustryLtd Carry?

As you can see below, Changchun Engley Automobile IndustryLtd had CN¥1.13b of debt at September 2024, down from CN¥1.51b a year prior. However, its balance sheet shows it holds CN¥1.39b in cash, so it actually has CN¥255.2m net cash.

A Look At Changchun Engley Automobile IndustryLtd's Liabilities

According to the last reported balance sheet, Changchun Engley Automobile IndustryLtd had liabilities of CN¥2.21b due within 12 months, and liabilities of CN¥859.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.39b as well as receivables valued at CN¥1.09b due within 12 months. So its liabilities total CN¥596.6m more than the combination of its cash and short-term receivables.

Since publicly traded Changchun Engley Automobile IndustryLtd shares are worth a total of CN¥6.39b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Changchun Engley Automobile IndustryLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

We saw Changchun Engley Automobile IndustryLtd grow its EBIT by 5.1% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Changchun Engley Automobile IndustryLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Changchun Engley Automobile IndustryLtd 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, Changchun Engley Automobile IndustryLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

We could understand if investors are concerned about Changchun Engley Automobile IndustryLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥255.2m. And it also grew its EBIT by 5.1% over the last year. So we don't have any problem with Changchun Engley Automobile IndustryLtd'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, we've discovered 2 warning signs for Changchun Engley Automobile IndustryLtd (1 is concerning!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.