These 4 Measures Indicate That CIMC Vehicles (Group) (HKG:1839) Is Using Debt Reasonably Well

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.' 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. We can see that CIMC Vehicles (Group) Co., Ltd. (HKG:1839) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for CIMC Vehicles (Group)

What Is CIMC Vehicles (Group)'s Debt?

As you can see below, CIMC Vehicles (Group) had CN¥1.23b of debt at December 2020, down from CN¥1.65b a year prior. However, its balance sheet shows it holds CN¥5.26b in cash, so it actually has CN¥4.04b net cash.

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

We can see from the most recent balance sheet that CIMC Vehicles (Group) had liabilities of CN¥8.61b falling due within a year, and liabilities of CN¥767.6m due beyond that. Offsetting these obligations, it had cash of CN¥5.26b as well as receivables valued at CN¥3.18b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥933.1m.

Of course, CIMC Vehicles (Group) has a market capitalization of CN¥9.53b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, CIMC Vehicles (Group) boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that CIMC Vehicles (Group) has increased its EBIT by 8.9% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. During the last three years, CIMC Vehicles (Group) produced sturdy free cash flow equating to 60% 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 it is always sensible to look at a company's total liabilities, it is very reassuring that CIMC Vehicles (Group) has CN¥4.04b in net cash. So we don't think CIMC Vehicles (Group)'s use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of CIMC Vehicles (Group)'s earnings per share history for free.

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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