China Automotive Engineering Research Institute (SHSE:601965) Seems To Use Debt Quite Sensibly

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.' 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 note that China Automotive Engineering Research Institute Co., Ltd. (SHSE:601965) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China Automotive Engineering Research Institute

What Is China Automotive Engineering Research Institute's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 China Automotive Engineering Research Institute had debt of CN¥54.5m, up from CN¥2.00m in one year. But on the other hand it also has CN¥1.50b in cash, leading to a CN¥1.44b net cash position.

How Strong Is China Automotive Engineering Research Institute's Balance Sheet?

According to the last reported balance sheet, China Automotive Engineering Research Institute had liabilities of CN¥1.85b due within 12 months, and liabilities of CN¥451.3m due beyond 12 months. On the other hand, it had cash of CN¥1.50b and CN¥2.53b worth of receivables due within a year. So it can boast CN¥1.73b more liquid assets than total liabilities.

This surplus suggests that China Automotive Engineering Research Institute has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, China Automotive Engineering Research Institute boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that China Automotive Engineering Research Institute grew its EBIT at 18% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if China Automotive Engineering Research Institute can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While China Automotive Engineering Research Institute has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, China Automotive Engineering Research Institute reported free cash flow worth 18% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Automotive Engineering Research Institute has net cash of CN¥1.44b, as well as more liquid assets than liabilities. And we liked the look of last year's 18% year-on-year EBIT growth. So we don't think China Automotive Engineering Research Institute's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that China Automotive Engineering Research Institute is showing 1 warning sign in our investment analysis , you should know about...

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.