Is Wuxi Autowell TechnologyLtd (SHSE:688516) 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.' 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. As with many other companies Wuxi Autowell Technology Co.,Ltd. (SHSE:688516) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Wuxi Autowell TechnologyLtd

How Much Debt Does Wuxi Autowell TechnologyLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Wuxi Autowell TechnologyLtd had CN¥2.22b of debt, an increase on CN¥1.68b, over one year. But it also has CN¥2.42b in cash to offset that, meaning it has CN¥208.5m net cash.

How Strong Is Wuxi Autowell TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wuxi Autowell TechnologyLtd had liabilities of CN¥8.50b due within 12 months and liabilities of CN¥1.50b due beyond that. Offsetting these obligations, it had cash of CN¥2.42b as well as receivables valued at CN¥3.06b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.52b.

While this might seem like a lot, it is not so bad since Wuxi Autowell TechnologyLtd has a market capitalization of CN¥13.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Wuxi Autowell TechnologyLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Wuxi Autowell TechnologyLtd has boosted its EBIT by 64%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Wuxi Autowell TechnologyLtd's ability to maintain a healthy balance sheet going forward. 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 Wuxi Autowell TechnologyLtd 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 last three years, Wuxi Autowell TechnologyLtd reported free cash flow worth 14% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

Although Wuxi Autowell TechnologyLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥208.5m. And we liked the look of last year's 64% year-on-year EBIT growth. So we don't have any problem with Wuxi Autowell TechnologyLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Wuxi Autowell TechnologyLtd (1 is a bit unpleasant!) that you should be aware of before investing here.

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.