Is Autek China (SZSE:300595) A Risky Investment?

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. We can see that Autek China Inc. (SZSE:300595) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Autek China

What Is Autek China's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Autek China had CN¥14.0m of debt, an increase on CN¥10.2m, over one year. But it also has CN¥2.18b in cash to offset that, meaning it has CN¥2.17b net cash.

How Strong Is Autek China's Balance Sheet?

According to the last reported balance sheet, Autek China had liabilities of CN¥669.8m due within 12 months, and liabilities of CN¥223.3m due beyond 12 months. Offsetting this, it had CN¥2.18b in cash and CN¥372.3m in receivables that were due within 12 months. So it actually has CN¥1.66b more liquid assets than total liabilities.

This short term liquidity is a sign that Autek China could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Autek China has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Autek China has increased its EBIT by 3.1% over twelve months, which should ease any concerns about debt repayment. 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 Autek China 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. While Autek China 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. During the last three years, Autek China produced sturdy free cash flow equating to 72% 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 Autek China has net cash of CN¥2.17b, as well as more liquid assets than liabilities. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in CN¥490m. So we don't think Autek China's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Autek China's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.