Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, CIMC Vehicles (Group) Co., Ltd. (HKG:1839) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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.
How Much Debt Does CIMC Vehicles (Group) Carry?
As you can see below, CIMC Vehicles (Group) had CN¥1.30b of debt at September 2021, down from CN¥1.83b a year prior. However, its balance sheet shows it holds CN¥5.48b in cash, so it actually has CN¥4.18b net cash.
How Healthy Is CIMC Vehicles (Group)'s Balance Sheet?
The latest balance sheet data shows that CIMC Vehicles (Group) had liabilities of CN¥9.98b due within a year, and liabilities of CN¥808.4m falling due after that. Offsetting these obligations, it had cash of CN¥5.48b as well as receivables valued at CN¥4.90b due within 12 months. So it has liabilities totalling CN¥399.1m more than its cash and near-term receivables, combined.
Of course, CIMC Vehicles (Group) has a market capitalization of CN¥18.2b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, CIMC Vehicles (Group) boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that CIMC Vehicles (Group) saw its EBIT decline by 2.0% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CIMC Vehicles (Group) 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. CIMC Vehicles (Group) 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, CIMC Vehicles (Group) recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that CIMC Vehicles (Group) has CN¥4.18b in net cash. So we are not troubled with CIMC Vehicles (Group)'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. For example, we've discovered 1 warning sign for CIMC Vehicles (Group) that you should be aware of before investing here.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.