China Railway Materials (SZSE:000927) Seems To Use Debt Quite Sensibly

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies China Railway Materials Company Limited (SZSE:000927) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China Railway Materials

What Is China Railway Materials's Net Debt?

As you can see below, China Railway Materials had CN¥1.63b of debt at September 2024, down from CN¥1.78b a year prior. But on the other hand it also has CN¥3.83b in cash, leading to a CN¥2.20b net cash position.

How Healthy Is China Railway Materials' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Railway Materials had liabilities of CN¥10.3b due within 12 months and liabilities of CN¥1.54b due beyond that. Offsetting these obligations, it had cash of CN¥3.83b as well as receivables valued at CN¥10.5b due within 12 months. So it can boast CN¥2.49b more liquid assets than total liabilities.

It's good to see that China Railway Materials has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, China Railway Materials boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for China Railway Materials if management cannot prevent a repeat of the 46% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is China Railway Materials'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China Railway Materials 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. During the last three years, China Railway Materials produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Railway Materials has net cash of CN¥2.20b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of -CN¥34m, being 74% of its EBIT. So is China Railway Materials's debt a risk? It doesn't seem so to us. 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 learn about the 2 warning signs we've spotted with China Railway Materials (including 1 which shouldn't be ignored) .

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.