China Southern Power Grid TechnologyLtd (SHSE:688248) Could Easily Take On More 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.' 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. We note that China Southern Power Grid Technology Co.,Ltd (SHSE:688248) 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 and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for China Southern Power Grid TechnologyLtd

What Is China Southern Power Grid TechnologyLtd's Debt?

As you can see below, at the end of September 2023, China Southern Power Grid TechnologyLtd had CN¥119.4m of debt, up from none a year ago. Click the image for more detail. However, it does have CN¥1.95b in cash offsetting this, leading to net cash of CN¥1.83b.

How Healthy Is China Southern Power Grid TechnologyLtd's Balance Sheet?

The latest balance sheet data shows that China Southern Power Grid TechnologyLtd had liabilities of CN¥1.24b due within a year, and liabilities of CN¥140.0m falling due after that. Offsetting this, it had CN¥1.95b in cash and CN¥782.3m in receivables that were due within 12 months. So it actually has CN¥1.35b more liquid assets than total liabilities.

This short term liquidity is a sign that China Southern Power Grid TechnologyLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, China Southern Power Grid TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, China Southern Power Grid TechnologyLtd grew its EBIT by 71% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China Southern Power Grid TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While China Southern Power Grid TechnologyLtd 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. During the last three years, China Southern Power Grid TechnologyLtd produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Southern Power Grid TechnologyLtd has net cash of CN¥1.83b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 71% over the last year. So is China Southern Power Grid TechnologyLtd's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with China Southern Power Grid TechnologyLtd .

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.