China XD Electric (SHSE:601179) Seems To Use Debt Rather Sparingly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies China XD Electric Co., Ltd (SHSE:601179) makes use of debt. But the real question is whether this debt is making the company risky.

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 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 XD Electric

How Much Debt Does China XD Electric Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 China XD Electric had CN¥1.26b of debt, an increase on CN¥804.0m, over one year. However, its balance sheet shows it holds CN¥10.3b in cash, so it actually has CN¥9.06b net cash.

How Healthy Is China XD Electric's Balance Sheet?

The latest balance sheet data shows that China XD Electric had liabilities of CN¥17.1b due within a year, and liabilities of CN¥1.88b falling due after that. On the other hand, it had cash of CN¥10.3b and CN¥13.6b worth of receivables due within a year. So it actually has CN¥4.94b more liquid assets than total liabilities.

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

Better yet, China XD Electric grew its EBIT by 116% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China XD Electric 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. China XD Electric 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. Happily for any shareholders, China XD Electric actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China XD Electric has net cash of CN¥9.06b, as well as more liquid assets than liabilities. The cherry on top was that in converted 140% of that EBIT to free cash flow, bringing in CN¥2.7b. So is China XD Electric's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. 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 China XD Electric 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com