Is Western Regions Tourism DevelopmentLtd (SZSE:300859) 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. We can see that Western Regions Tourism Development Co.,Ltd (SZSE:300859) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Western Regions Tourism DevelopmentLtd

What Is Western Regions Tourism DevelopmentLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Western Regions Tourism DevelopmentLtd had CN¥99.4m of debt, an increase on none, over one year. However, its balance sheet shows it holds CN¥350.8m in cash, so it actually has CN¥251.4m net cash.

How Strong Is Western Regions Tourism DevelopmentLtd's Balance Sheet?

We can see from the most recent balance sheet that Western Regions Tourism DevelopmentLtd had liabilities of CN¥36.7m falling due within a year, and liabilities of CN¥119.2m due beyond that. On the other hand, it had cash of CN¥350.8m and CN¥6.81m worth of receivables due within a year. So it actually has CN¥201.7m more liquid assets than total liabilities.

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

On the other hand, Western Regions Tourism DevelopmentLtd's EBIT dived 14%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Western Regions Tourism DevelopmentLtd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Western Regions Tourism DevelopmentLtd 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. Looking at the most recent two years, Western Regions Tourism DevelopmentLtd recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Western Regions Tourism DevelopmentLtd has CN¥251.4m in net cash and a decent-looking balance sheet. So we don't have any problem with Western Regions Tourism DevelopmentLtd's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Western Regions Tourism DevelopmentLtd (of which 1 is significant!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.