Is Jade Bird Fire (SZSE:002960) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Jade Bird Fire Co., Ltd. (SZSE:002960) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Jade Bird Fire

What Is Jade Bird Fire's Net Debt?

The image below, which you can click on for greater detail, shows that Jade Bird Fire had debt of CN¥495.0m at the end of June 2024, a reduction from CN¥521.7m over a year. However, it does have CN¥2.19b in cash offsetting this, leading to net cash of CN¥1.69b.

A Look At Jade Bird Fire's Liabilities

We can see from the most recent balance sheet that Jade Bird Fire had liabilities of CN¥1.58b falling due within a year, and liabilities of CN¥331.7m due beyond that. Offsetting this, it had CN¥2.19b in cash and CN¥2.96b in receivables that were due within 12 months. So it actually has CN¥3.24b more liquid assets than total liabilities.

This surplus liquidity suggests that Jade Bird Fire's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Jade Bird Fire boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Jade Bird Fire saw its EBIT drop by 8.8% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder 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 Jade Bird Fire can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Jade Bird Fire 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. Looking at the most recent three years, Jade Bird Fire recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Jade Bird Fire has CN¥1.69b in net cash and a decent-looking balance sheet. So we are not troubled with Jade Bird Fire's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Jade Bird Fire you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.