Is Xinchen China Power Holdings (HKG:1148) Using Debt Sensibly?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Xinchen China Power Holdings Limited (HKG:1148) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Xinchen China Power Holdings

What Is Xinchen China Power Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Xinchen China Power Holdings had CN¥675.4m of debt in June 2024, down from CN¥801.0m, one year before. However, it does have CN¥41.4m in cash offsetting this, leading to net debt of about CN¥634.0m.

A Look At Xinchen China Power Holdings' Liabilities

We can see from the most recent balance sheet that Xinchen China Power Holdings had liabilities of CN¥2.96b falling due within a year, and liabilities of CN¥379.5m due beyond that. Offsetting this, it had CN¥41.4m in cash and CN¥2.00b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.30b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥167.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Xinchen China Power Holdings would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Xinchen China Power Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

In the last year Xinchen China Power Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 67%, to CN¥5.7b. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Xinchen China Power Holdings's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Its EBIT loss was a whopping CN¥27m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Sure, the company might have a nice story about how they are going on to a brighter future. But we note that trailing twelve month EBIT is worse than the free cash flow of CN¥200m and the profit of CN¥41m. So its situation may not be as precarious as the EBIT would imply. 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. For example - Xinchen China Power Holdings has 3 warning signs we think you should be aware of.

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.