Is Wuxi Paike New Materials TechnologyLtd (SHSE:605123) Using Too Much Debt?

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. We can see that Wuxi Paike New Materials Technology Co.,Ltd. (SHSE:605123) does use debt in its business. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Wuxi Paike New Materials TechnologyLtd

What Is Wuxi Paike New Materials TechnologyLtd's Debt?

As you can see below, at the end of September 2023, Wuxi Paike New Materials TechnologyLtd had CN¥420.3m of debt, up from CN¥210.2m a year ago. Click the image for more detail. But it also has CN¥1.68b in cash to offset that, meaning it has CN¥1.26b net cash.

How Strong Is Wuxi Paike New Materials TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Wuxi Paike New Materials TechnologyLtd had liabilities of CN¥2.21b falling due within a year, and liabilities of CN¥358.7m due beyond that. Offsetting these obligations, it had cash of CN¥1.68b as well as receivables valued at CN¥2.29b due within 12 months. So it can boast CN¥1.40b more liquid assets than total liabilities.

It's good to see that Wuxi Paike New Materials TechnologyLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Wuxi Paike New Materials TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Wuxi Paike New Materials TechnologyLtd grew its EBIT by 19% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Wuxi Paike New Materials TechnologyLtd 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 company can only pay off debt with cold hard cash, not accounting profits. Wuxi Paike New Materials TechnologyLtd 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, Wuxi Paike New Materials TechnologyLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Wuxi Paike New Materials TechnologyLtd has CN¥1.26b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 19% over the last year. So we are not troubled with Wuxi Paike New Materials TechnologyLtd's debt use. 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 learn about the 2 warning signs we've spotted with Wuxi Paike New Materials TechnologyLtd (including 1 which is potentially serious) .

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.