Is North Industries Group Red Arrow (SZSE:000519) Using Too Much 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.' 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 North Industries Group Red Arrow Co., Ltd (SZSE:000519) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for North Industries Group Red Arrow

What Is North Industries Group Red Arrow's Net Debt?

The image below, which you can click on for greater detail, shows that North Industries Group Red Arrow had debt of CN¥206.4m at the end of March 2024, a reduction from CN¥335.0m over a year. But on the other hand it also has CN¥6.04b in cash, leading to a CN¥5.84b net cash position.

A Look At North Industries Group Red Arrow's Liabilities

We can see from the most recent balance sheet that North Industries Group Red Arrow had liabilities of CN¥3.87b falling due within a year, and liabilities of CN¥781.8m due beyond that. Offsetting this, it had CN¥6.04b in cash and CN¥2.03b in receivables that were due within 12 months. So it can boast CN¥3.42b more liquid assets than total liabilities.

This surplus suggests that North Industries Group Red Arrow is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that North Industries Group Red Arrow has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, North Industries Group Red Arrow grew its EBIT by 60% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine North Industries Group Red Arrow'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While North Industries Group Red Arrow 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. Looking at the most recent three years, North Industries Group Red Arrow recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that North Industries Group Red Arrow has net cash of CN¥5.84b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 60% over the last year. So we don't think North Industries Group Red Arrow's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of North Industries Group Red Arrow's earnings per share history for free.

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.