Here's Why China High-Speed Railway Technology (SZSE:000008) Can Afford Some Debt

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 China High-Speed Railway Technology Co., Ltd. (SZSE:000008) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 China High-Speed Railway Technology

What Is China High-Speed Railway Technology's Net Debt?

As you can see below, China High-Speed Railway Technology had CN¥3.81b of debt at September 2023, down from CN¥4.09b a year prior. However, it also had CN¥357.2m in cash, and so its net debt is CN¥3.46b.

How Strong Is China High-Speed Railway Technology's Balance Sheet?

The latest balance sheet data shows that China High-Speed Railway Technology had liabilities of CN¥5.82b due within a year, and liabilities of CN¥934.7m falling due after that. On the other hand, it had cash of CN¥357.2m and CN¥2.79b worth of receivables due within a year. So its liabilities total CN¥3.61b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since China High-Speed Railway Technology has a market capitalization of CN¥6.36b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China High-Speed Railway Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year China High-Speed Railway Technology's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Importantly, China High-Speed Railway Technology had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥423m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥70m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with China High-Speed Railway Technology (including 1 which can't be ignored) .

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.