Contemporary Amperex Technology (SZSE:300750) Seems To Use Debt Quite Sensibly

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 Contemporary Amperex Technology Co., Limited (SZSE:300750) 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 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. 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 Contemporary Amperex Technology

How Much Debt Does Contemporary Amperex Technology Carry?

As you can see below, at the end of September 2023, Contemporary Amperex Technology had CN¥121.1b of debt, up from CN¥84.1b a year ago. Click the image for more detail. However, it does have CN¥233.8b in cash offsetting this, leading to net cash of CN¥112.7b.

How Healthy Is Contemporary Amperex Technology's Balance Sheet?

According to the last reported balance sheet, Contemporary Amperex Technology had liabilities of CN¥276.2b due within 12 months, and liabilities of CN¥193.6b due beyond 12 months. Offsetting this, it had CN¥233.8b in cash and CN¥112.6b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥123.4b.

Of course, Contemporary Amperex Technology has a titanic market capitalization of CN¥690.7b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Contemporary Amperex Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Contemporary Amperex Technology grew its EBIT by 99% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Contemporary Amperex Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Contemporary Amperex Technology 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, Contemporary Amperex Technology's free cash flow amounted to 50% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Contemporary Amperex Technology'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¥112.7b. And it impressed us with its EBIT growth of 99% over the last year. So we don't think Contemporary Amperex Technology's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Contemporary Amperex Technology's earnings per share history for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.