Here's Why CIMC Vehicles (Group) (HKG:1839) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, CIMC Vehicles (Group) Co., Ltd. (HKG:1839) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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, 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.

View our latest analysis for CIMC Vehicles (Group)

What Is CIMC Vehicles (Group)'s Debt?

As you can see below, at the end of March 2022, CIMC Vehicles (Group) had CN¥1.47b of debt, up from CN¥1.18b a year ago. Click the image for more detail. But on the other hand it also has CN¥4.42b in cash, leading to a CN¥2.96b net cash position.

A Look At CIMC Vehicles (Group)'s Liabilities

According to the last reported balance sheet, CIMC Vehicles (Group) had liabilities of CN¥9.30b due within 12 months, and liabilities of CN¥765.2m due beyond 12 months. Offsetting this, it had CN¥4.42b in cash and CN¥4.32b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.33b more than its cash and near-term receivables, combined.

Since publicly traded CIMC Vehicles (Group) shares are worth a total of CN¥11.3b, it seems unlikely that this level of liabilities would be a major threat. 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!

In fact CIMC Vehicles (Group)'s saving grace is its low debt levels, because its EBIT has tanked 65% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CIMC Vehicles (Group) can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While CIMC Vehicles (Group) 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. In the last three years, CIMC Vehicles (Group) created free cash flow amounting to 19% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

Although CIMC Vehicles (Group)'s balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥2.96b. So we don't have any problem with CIMC Vehicles (Group)'s use of debt. 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. Be aware that CIMC Vehicles (Group) is showing 2 warning signs in our investment analysis , and 1 of those is significant...

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.