XJ Electric (SZSE:000400) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies XJ Electric Co., Ltd. (SZSE:000400) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for XJ Electric

What Is XJ Electric's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 XJ Electric had debt of CN¥60.0m, up from CN¥17.9m in one year. However, it does have CN¥5.35b in cash offsetting this, leading to net cash of CN¥5.29b.

How Healthy Is XJ Electric's Balance Sheet?

According to the last reported balance sheet, XJ Electric had liabilities of CN¥10.8b due within 12 months, and liabilities of CN¥330.2m due beyond 12 months. Offsetting this, it had CN¥5.35b in cash and CN¥9.37b in receivables that were due within 12 months. So it can boast CN¥3.60b more liquid assets than total liabilities.

This short term liquidity is a sign that XJ Electric could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that XJ Electric has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that XJ Electric has increased its EBIT by 2.9% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine XJ Electric'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. XJ 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, XJ 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 XJ Electric has net cash of CN¥5.29b, as well as more liquid assets than liabilities. The cherry on top was that in converted 169% of that EBIT to free cash flow, bringing in CN¥1.7b. So we don't think XJ Electric's use of debt is risky. 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. For example, we've discovered 1 warning sign for XJ Electric that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.