XJ Electric (SZSE:000400) Seems To Use Debt Rather Sparingly

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.' 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 XJ Electric Co., Ltd. (SZSE:000400) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for XJ Electric

What Is XJ Electric's Net Debt?

As you can see below, at the end of September 2024, XJ Electric had CN¥60.0m of debt, up from CN¥17.9m a year ago. Click the image for more detail. 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. On the other hand, it had cash of CN¥5.35b and CN¥9.37b worth of receivables due within a year. So it actually has 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. 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 XJ Electric 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last three years, XJ Electric actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with XJ Electric , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.