Xizi Clean Energy Equipment Manufacturing (SZSE:002534) Takes On Some Risk With Its Use Of 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.' 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. We note that Xizi Clean Energy Equipment Manufacturing Co., Ltd. (SZSE:002534) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Xizi Clean Energy Equipment Manufacturing

What Is Xizi Clean Energy Equipment Manufacturing's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Xizi Clean Energy Equipment Manufacturing had debt of CN¥2.83b, up from CN¥2.56b in one year. But it also has CN¥3.42b in cash to offset that, meaning it has CN¥586.8m net cash.

A Look At Xizi Clean Energy Equipment Manufacturing's Liabilities

Zooming in on the latest balance sheet data, we can see that Xizi Clean Energy Equipment Manufacturing had liabilities of CN¥9.65b due within 12 months and liabilities of CN¥2.61b due beyond that. Offsetting these obligations, it had cash of CN¥3.42b as well as receivables valued at CN¥5.13b due within 12 months. So its liabilities total CN¥3.72b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Xizi Clean Energy Equipment Manufacturing is worth CN¥7.65b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Xizi Clean Energy Equipment Manufacturing boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Xizi Clean Energy Equipment Manufacturing's load is not too heavy, because its EBIT was down 74% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Xizi Clean Energy Equipment Manufacturing can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Xizi Clean Energy Equipment Manufacturing 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. During the last three years, Xizi Clean Energy Equipment Manufacturing burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

Although Xizi Clean Energy Equipment Manufacturing's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥586.8m. Despite its cash we think that Xizi Clean Energy Equipment Manufacturing seems to struggle to grow its EBIT, so we are wary of the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Xizi Clean Energy Equipment Manufacturing that you should be aware of before investing here.

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.