Is China Design Group (SHSE:603018) A Risky Investment?

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 China Design Group Co., Ltd. (SHSE:603018) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China Design Group

How Much Debt Does China Design Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 China Design Group had CN¥758.0m of debt, an increase on CN¥649.1m, over one year. But it also has CN¥1.49b in cash to offset that, meaning it has CN¥728.4m net cash.

A Look At China Design Group's Liabilities

Zooming in on the latest balance sheet data, we can see that China Design Group had liabilities of CN¥6.87b due within 12 months and liabilities of CN¥433.6m due beyond that. On the other hand, it had cash of CN¥1.49b and CN¥8.42b worth of receivables due within a year. So it actually has CN¥2.60b more liquid assets than total liabilities.

This excess liquidity is a great indication that China Design Group's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, China Design Group boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that China Design Group has seen its EBIT plunge 17% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if China Design Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China Design Group 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. Looking at the most recent three years, China Design Group recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Design Group has net cash of CN¥728.4m, as well as more liquid assets than liabilities. So we are not troubled with China Design Group's debt use. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check China Design Group's dividend history, without delay!

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.