These 4 Measures Indicate That Shantui Construction Machinery (SZSE:000680) Is Using Debt Safely

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. We note that Shantui Construction Machinery Co., Ltd. (SZSE:000680) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shantui Construction Machinery

How Much Debt Does Shantui Construction Machinery Carry?

As you can see below, Shantui Construction Machinery had CN¥760.0m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥3.91b in cash to offset that, meaning it has CN¥3.15b net cash.

A Look At Shantui Construction Machinery's Liabilities

The latest balance sheet data shows that Shantui Construction Machinery had liabilities of CN¥8.29b due within a year, and liabilities of CN¥409.7m falling due after that. Offsetting this, it had CN¥3.91b in cash and CN¥4.97b in receivables that were due within 12 months. So it actually has CN¥179.9m more liquid assets than total liabilities.

Having regard to Shantui Construction Machinery's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥11.7b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Shantui Construction Machinery has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Shantui Construction Machinery grew its EBIT by 133% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Shantui Construction Machinery'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. While Shantui Construction Machinery 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. In the last three years, Shantui Construction Machinery's free cash flow amounted to 41% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shantui Construction Machinery has CN¥3.15b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 133% over the last year. So we don't think Shantui Construction Machinery's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Shantui Construction Machinery you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.