Is Xiamen East Asia Machinery Industrial (SZSE:301028) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Xiamen East Asia Machinery Industrial Co., Ltd. (SZSE:301028) does use debt in its business. But is this debt a concern to shareholders?

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. 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.

Check out our latest analysis for Xiamen East Asia Machinery Industrial

How Much Debt Does Xiamen East Asia Machinery Industrial Carry?

As you can see below, at the end of June 2024, Xiamen East Asia Machinery Industrial had CN¥67.8m of debt, up from none a year ago. Click the image for more detail. However, it does have CN¥441.2m in cash offsetting this, leading to net cash of CN¥373.4m.

How Healthy Is Xiamen East Asia Machinery Industrial's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Xiamen East Asia Machinery Industrial had liabilities of CN¥590.8m due within 12 months and liabilities of CN¥87.5m due beyond that. On the other hand, it had cash of CN¥441.2m and CN¥260.6m worth of receivables due within a year. So it actually has CN¥23.4m more liquid assets than total liabilities.

Having regard to Xiamen East Asia Machinery Industrial's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥4.08b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Xiamen East Asia Machinery Industrial boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Xiamen East Asia Machinery Industrial grew its EBIT by 35% 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 you can't view debt in total isolation; since Xiamen East Asia Machinery Industrial will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Xiamen East Asia Machinery Industrial 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. Over the most recent three years, Xiamen East Asia Machinery Industrial recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Xiamen East Asia Machinery Industrial has CN¥373.4m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 35% over the last year. So is Xiamen East Asia Machinery Industrial's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Xiamen East Asia Machinery Industrial has 2 warning signs (and 1 which can't be ignored) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.