We Think China Railway Hi-tech Industry (SHSE:600528) Is Taking Some Risk With Its Debt

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 note that China Railway Hi-tech Industry Corporation Limited (SHSE:600528) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for China Railway Hi-tech Industry

What Is China Railway Hi-tech Industry's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 China Railway Hi-tech Industry had debt of CN¥461.4m, up from CN¥214.8m in one year. However, its balance sheet shows it holds CN¥4.49b in cash, so it actually has CN¥4.03b net cash.

How Strong Is China Railway Hi-tech Industry's Balance Sheet?

According to the last reported balance sheet, China Railway Hi-tech Industry had liabilities of CN¥35.6b due within 12 months, and liabilities of CN¥702.8m due beyond 12 months. Offsetting this, it had CN¥4.49b in cash and CN¥20.1b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥11.6b.

This deficit is considerable relative to its market capitalization of CN¥15.6b, so it does suggest shareholders should keep an eye on China Railway Hi-tech Industry's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, China Railway Hi-tech Industry boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, China Railway Hi-tech Industry's EBIT dived 15%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Railway Hi-tech Industry will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Railway Hi-tech Industry 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, China Railway Hi-tech Industry recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While China Railway Hi-tech Industry does have more liabilities than liquid assets, it also has net cash of CN¥4.03b. Despite its cash we think that China Railway Hi-tech Industry seems to struggle to convert EBIT to free cash flow, so we are wary of the stock. 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 Railway Hi-tech Industry is showing 1 warning sign in our investment analysis , you should know about...

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.