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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Chengdu RML Technology Co., Ltd. (SZSE:301050) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Chengdu RML Technology
What Is Chengdu RML Technology's Net Debt?
As you can see below, Chengdu RML Technology had CN¥30.0m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥2.04b in cash, so it actually has CN¥2.01b net cash.
A Look At Chengdu RML Technology's Liabilities
We can see from the most recent balance sheet that Chengdu RML Technology had liabilities of CN¥1.50b falling due within a year, and liabilities of CN¥29.4m due beyond that. Offsetting these obligations, it had cash of CN¥2.04b as well as receivables valued at CN¥148.5m due within 12 months. So it can boast CN¥660.5m more liquid assets than total liabilities.
This short term liquidity is a sign that Chengdu RML Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Chengdu RML Technology has more cash than debt is arguably a good indication that it can manage its debt safely.
Also positive, Chengdu RML Technology grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chengdu RML 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Chengdu RML Technology 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, Chengdu RML Technology 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
While it is always sensible to investigate a company's debt, in this case Chengdu RML Technology has CN¥2.01b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 103% of that EBIT to free cash flow, bringing in CN¥852m. So is Chengdu RML Technology'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. We've identified 1 warning sign with Chengdu RML Technology , and understanding them should be part of your investment process.
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.
About SZSE:301050
Chengdu RML Technology
Engages in the research, development, manufacture, and testing of millimeter-wave microsystems.
Flawless balance sheet second-rate dividend payer.