We Think Chongqing Changan Automobile (SZSE:000625) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Chongqing Changan Automobile Company Limited (SZSE:000625) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Chongqing Changan Automobile

What Is Chongqing Changan Automobile's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Chongqing Changan Automobile had debt of CN¥1.21b, up from CN¥1.13b in one year. However, its balance sheet shows it holds CN¥70.2b in cash, so it actually has CN¥69.0b net cash.

How Healthy Is Chongqing Changan Automobile's Balance Sheet?

The latest balance sheet data shows that Chongqing Changan Automobile had liabilities of CN¥101.9b due within a year, and liabilities of CN¥12.9b falling due after that. Offsetting these obligations, it had cash of CN¥70.2b as well as receivables valued at CN¥38.5b due within 12 months. So it has liabilities totalling CN¥6.09b more than its cash and near-term receivables, combined.

Given Chongqing Changan Automobile has a humongous market capitalization of CN¥117.5b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Chongqing Changan Automobile boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Chongqing Changan Automobile's EBIT fell a jaw-dropping 63% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Chongqing Changan Automobile can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Chongqing Changan Automobile 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, Chongqing Changan Automobile actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

We could understand if investors are concerned about Chongqing Changan Automobile's liabilities, but we can be reassured by the fact it has has net cash of CN¥69.0b. And it impressed us with free cash flow of CN¥19b, being 317% of its EBIT. So we are not troubled with Chongqing Changan Automobile's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Chongqing Changan Automobile is showing 3 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.