Is Jiangsu Rainbow Heavy Industries (SZSE:002483) A Risky Investment?

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 Jiangsu Rainbow Heavy Industries Co., Ltd. (SZSE:002483) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Jiangsu Rainbow Heavy Industries

What Is Jiangsu Rainbow Heavy Industries's Debt?

The chart below, which you can click on for greater detail, shows that Jiangsu Rainbow Heavy Industries had CN¥1.09b in debt in September 2024; about the same as the year before. However, its balance sheet shows it holds CN¥3.44b in cash, so it actually has CN¥2.36b net cash.

A Look At Jiangsu Rainbow Heavy Industries' Liabilities

We can see from the most recent balance sheet that Jiangsu Rainbow Heavy Industries had liabilities of CN¥5.36b falling due within a year, and liabilities of CN¥533.7m due beyond that. Offsetting this, it had CN¥3.44b in cash and CN¥2.03b in receivables that were due within 12 months. So its liabilities total CN¥422.2m more than the combination of its cash and short-term receivables.

Since publicly traded Jiangsu Rainbow Heavy Industries shares are worth a total of CN¥6.05b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Jiangsu Rainbow Heavy Industries also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Jiangsu Rainbow Heavy Industries has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jiangsu Rainbow Heavy Industries's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Jiangsu Rainbow Heavy Industries 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, Jiangsu Rainbow Heavy Industries 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

We could understand if investors are concerned about Jiangsu Rainbow Heavy Industries's liabilities, but we can be reassured by the fact it has has net cash of CN¥2.36b. The cherry on top was that in converted 182% of that EBIT to free cash flow, bringing in -CN¥405m. So we don't think Jiangsu Rainbow Heavy Industries's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Jiangsu Rainbow Heavy Industries that 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.