Is China Security (SHSE:600654) A Risky Investment?

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.' 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. Importantly, China Security Co., Ltd. (SHSE:600654) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 China Security

What Is China Security's Net Debt?

The image below, which you can click on for greater detail, shows that China Security had debt of CN¥218.6m at the end of September 2024, a reduction from CN¥287.5m over a year. However, it does have CN¥547.7m in cash offsetting this, leading to net cash of CN¥329.2m.

How Strong Is China Security's Balance Sheet?

The latest balance sheet data shows that China Security had liabilities of CN¥1.68b due within a year, and liabilities of CN¥270.6m falling due after that. On the other hand, it had cash of CN¥547.7m and CN¥1.58b worth of receivables due within a year. So it can boast CN¥175.5m more liquid assets than total liabilities.

This state of affairs indicates that China Security's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥9.26b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that China Security has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, China Security turned things around in the last 12 months, delivering and EBIT of CN¥61m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Security will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China Security 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. Over the last year, China Security saw substantial negative free cash flow, in total. 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 we empathize with investors who find debt concerning, you should keep in mind that China Security has net cash of CN¥329.2m, as well as more liquid assets than liabilities. So we don't have any problem with China Security's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with China Security .

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.