Is Centre Testing International Group (SZSE:300012) A Risky Investment?

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. Importantly, Centre Testing International Group Co. Ltd. (SZSE:300012) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Centre Testing International Group

What Is Centre Testing International Group's Net Debt?

The image below, which you can click on for greater detail, shows that Centre Testing International Group had debt of CN¥128.9m at the end of September 2023, a reduction from CN¥162.7m over a year. But on the other hand it also has CN¥1.12b in cash, leading to a CN¥995.0m net cash position.

How Healthy Is Centre Testing International Group's Balance Sheet?

According to the last reported balance sheet, Centre Testing International Group had liabilities of CN¥1.50b due within 12 months, and liabilities of CN¥492.0m due beyond 12 months. Offsetting this, it had CN¥1.12b in cash and CN¥2.05b in receivables that were due within 12 months. So it can boast CN¥1.18b more liquid assets than total liabilities.

This surplus suggests that Centre Testing International Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Centre Testing International Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Centre Testing International Group grew its EBIT at 15% over the last year, further increasing its ability to manage debt. 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 Centre Testing International Group can strengthen its balance sheet over time. 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. Centre Testing International 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. During the last three years, Centre Testing International Group produced sturdy free cash flow equating to 50% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Centre Testing International Group has net cash of CN¥995.0m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 15% over the last year. So is Centre Testing International Group's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Centre Testing International Group, you may well want to click here to check an interactive graph of its earnings per share history.

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.