Is Winall Hi-tech Seed (SZSE:300087) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Winall Hi-tech Seed Co., Ltd. (SZSE:300087) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. 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.

Check out our latest analysis for Winall Hi-tech Seed

How Much Debt Does Winall Hi-tech Seed Carry?

The image below, which you can click on for greater detail, shows that at December 2023 Winall Hi-tech Seed had debt of CN¥1.16b, up from CN¥893.5m in one year. But it also has CN¥1.54b in cash to offset that, meaning it has CN¥380.5m net cash.

A Look At Winall Hi-tech Seed's Liabilities

The latest balance sheet data shows that Winall Hi-tech Seed had liabilities of CN¥3.36b due within a year, and liabilities of CN¥765.5m falling due after that. Offsetting these obligations, it had cash of CN¥1.54b as well as receivables valued at CN¥582.6m due within 12 months. So its liabilities total CN¥2.01b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Winall Hi-tech Seed has a market capitalization of CN¥7.29b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Winall Hi-tech Seed also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Winall Hi-tech Seed grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its 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 Winall Hi-tech Seed 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Winall Hi-tech Seed 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 last three years, Winall Hi-tech Seed recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While Winall Hi-tech Seed does have more liabilities than liquid assets, it also has net cash of CN¥380.5m. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in CN¥90m. So is Winall Hi-tech Seed's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Winall Hi-tech Seed .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.