These 4 Measures Indicate That Xinjiang Communications Construction Group (SZSE:002941) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Xinjiang Communications Construction Group Co., Ltd. (SZSE:002941) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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, 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Xinjiang Communications Construction Group

What Is Xinjiang Communications Construction Group's Debt?

As you can see below, at the end of September 2024, Xinjiang Communications Construction Group had CN¥6.77b of debt, up from CN¥6.27b a year ago. Click the image for more detail. However, it does have CN¥2.48b in cash offsetting this, leading to net debt of about CN¥4.29b.

A Look At Xinjiang Communications Construction Group's Liabilities

According to the last reported balance sheet, Xinjiang Communications Construction Group had liabilities of CN¥8.54b due within 12 months, and liabilities of CN¥5.25b due beyond 12 months. On the other hand, it had cash of CN¥2.48b and CN¥6.19b worth of receivables due within a year. So it has liabilities totalling CN¥5.13b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥7.69b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Xinjiang Communications Construction Group's debt to EBITDA ratio of 7.0 suggests a heavy debt load, its interest coverage of 9.7 implies it services that debt with ease. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. If Xinjiang Communications Construction Group can keep growing EBIT at last year's rate of 19% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Xinjiang Communications Construction Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Xinjiang Communications Construction Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Xinjiang Communications Construction Group's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Xinjiang Communications Construction Group stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Xinjiang Communications Construction Group you should be aware of, and 1 of them is a bit unpleasant.

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.