Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Xiamen Kingdomway Group Company (SZSE:002626) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Xiamen Kingdomway Group
How Much Debt Does Xiamen Kingdomway Group Carry?
You can click the graphic below for the historical numbers, but it shows that Xiamen Kingdomway Group had CN¥527.8m of debt in September 2023, down from CN¥1.02b, one year before. But on the other hand it also has CN¥796.0m in cash, leading to a CN¥268.2m net cash position.
How Strong Is Xiamen Kingdomway Group's Balance Sheet?
We can see from the most recent balance sheet that Xiamen Kingdomway Group had liabilities of CN¥506.1m falling due within a year, and liabilities of CN¥974.8m due beyond that. Offsetting this, it had CN¥796.0m in cash and CN¥396.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥288.9m.
Of course, Xiamen Kingdomway Group has a market capitalization of CN¥8.61b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Xiamen Kingdomway Group boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Xiamen Kingdomway Group if management cannot prevent a repeat of the 43% cut to EBIT over the last year. 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 you can't view debt in total isolation; since Xiamen Kingdomway Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Xiamen Kingdomway Group 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, Xiamen Kingdomway Group generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Summing Up
We could understand if investors are concerned about Xiamen Kingdomway Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥268.2m. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in CN¥563m. So we are not troubled with Xiamen Kingdomway Group's debt use. 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. For example Xiamen Kingdomway Group has 4 warning signs (and 1 which shouldn't be ignored) we think 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.
About SZSE:002626
Xiamen Kingdomway Group
Engages in the manufacturing and sale of the nutrition and health products in China and internationally.
Flawless balance sheet with reasonable growth potential and pays a dividend.