Is CIMC Vehicles (Group) (HKG:1839) Using Too Much 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. As with many other companies CIMC Vehicles (Group) Co., Ltd. (HKG:1839) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for CIMC Vehicles (Group)

What Is CIMC Vehicles (Group)'s Net Debt?

As you can see below, at the end of March 2022, CIMC Vehicles (Group) had CN¥1.47b of debt, up from none a year ago. Click the image for more detail. But it also has CN¥4.42b in cash to offset that, meaning it has CN¥2.96b net cash.

How Healthy Is CIMC Vehicles (Group)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CIMC Vehicles (Group) had liabilities of CN¥9.30b due within 12 months and liabilities of CN¥765.2m due beyond that. On the other hand, it had cash of CN¥4.42b and CN¥4.32b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.33b.

Since publicly traded CIMC Vehicles (Group) shares are worth a total of CN¥18.5b, 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. While it does have liabilities worth noting, CIMC Vehicles (Group) also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that CIMC Vehicles (Group)'s load is not too heavy, because its EBIT was down 49% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine CIMC Vehicles (Group)'s ability to maintain a healthy balance sheet going forward. 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. 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)'s free cash flow amounted to 27% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that CIMC Vehicles (Group) has CN¥2.96b 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for CIMC Vehicles (Group) (of which 1 doesn't sit too well with us!) you should know about.

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.