Is Xi'an NovaStar Tech (SZSE:301589) 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. We can see that Xi'an NovaStar Tech Co., Ltd. (SZSE:301589) does use debt in its business. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Xi'an NovaStar Tech

How Much Debt Does Xi'an NovaStar Tech Carry?

As you can see below, Xi'an NovaStar Tech had CN¥398.0m of debt at September 2024, down from CN¥662.3m a year prior. But on the other hand it also has CN¥979.0m in cash, leading to a CN¥581.0m net cash position.

How Strong Is Xi'an NovaStar Tech's Balance Sheet?

We can see from the most recent balance sheet that Xi'an NovaStar Tech had liabilities of CN¥1.17b falling due within a year, and liabilities of CN¥386.9m due beyond that. Offsetting these obligations, it had cash of CN¥979.0m as well as receivables valued at CN¥1.22b due within 12 months. So it can boast CN¥636.8m more liquid assets than total liabilities.

This surplus suggests that Xi'an NovaStar Tech has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Xi'an NovaStar Tech boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Xi'an NovaStar Tech grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Xi'an NovaStar Tech 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Xi'an NovaStar Tech 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, Xi'an NovaStar Tech burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Xi'an NovaStar Tech has net cash of CN¥581.0m, as well as more liquid assets than liabilities. And we liked the look of last year's 25% year-on-year EBIT growth. So we don't have any problem with Xi'an NovaStar Tech's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Xi'an NovaStar Tech (1 is potentially serious) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.