Is Qinghai Salt Lake IndustryLtd (SZSE:000792) 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.' 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 note that Qinghai Salt Lake Industry Co.,Ltd (SZSE:000792) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Qinghai Salt Lake IndustryLtd

How Much Debt Does Qinghai Salt Lake IndustryLtd Carry?

As you can see below, Qinghai Salt Lake IndustryLtd had CN¥6.82b of debt at September 2023, down from CN¥8.41b a year prior. But it also has CN¥24.5b in cash to offset that, meaning it has CN¥17.7b net cash.

A Look At Qinghai Salt Lake IndustryLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Qinghai Salt Lake IndustryLtd had liabilities of CN¥8.93b due within 12 months and liabilities of CN¥6.88b due beyond that. On the other hand, it had cash of CN¥24.5b and CN¥10.4b worth of receivables due within a year. So it can boast CN¥19.1b more liquid assets than total liabilities.

This excess liquidity suggests that Qinghai Salt Lake IndustryLtd is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Qinghai Salt Lake IndustryLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Qinghai Salt Lake IndustryLtd's saving grace is its low debt levels, because its EBIT has tanked 34% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Qinghai Salt Lake IndustryLtd 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. While Qinghai Salt Lake IndustryLtd 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. Over the most recent three years, Qinghai Salt Lake IndustryLtd recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 Qinghai Salt Lake IndustryLtd has net cash of CN¥17.7b, as well as more liquid assets than liabilities. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in CN¥13b. So we don't think Qinghai Salt Lake IndustryLtd's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Qinghai Salt Lake IndustryLtd, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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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.