Is Shantui Construction Machinery (SZSE:000680) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Shantui Construction Machinery Co., Ltd. (SZSE:000680) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shantui Construction Machinery

How Much Debt Does Shantui Construction Machinery Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Shantui Construction Machinery had debt of CN¥761.4m, up from CN¥579.0m in one year. However, its balance sheet shows it holds CN¥4.27b in cash, so it actually has CN¥3.50b net cash.

How Healthy Is Shantui Construction Machinery's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shantui Construction Machinery had liabilities of CN¥9.01b due within 12 months and liabilities of CN¥424.3m due beyond that. Offsetting these obligations, it had cash of CN¥4.27b as well as receivables valued at CN¥5.13b due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Shantui Construction Machinery's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥15.1b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Shantui Construction Machinery boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Shantui Construction Machinery has boosted its EBIT by 71%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shantui Construction Machinery 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Shantui Construction Machinery 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. In the last three years, Shantui Construction Machinery's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about Shantui Construction Machinery's liabilities, but we can be reassured by the fact it has has net cash of CN¥3.50b. And we liked the look of last year's 71% year-on-year EBIT growth. So is Shantui Construction Machinery'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. However, not all investment risk resides within the balance sheet - far from it. For example - Shantui Construction Machinery has 1 warning sign we think you should be aware of.

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.