Beijing Jingcheng Machinery Electric (HKG:187) Is Making Moderate Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Beijing Jingcheng Machinery Electric Company Limited (HKG:187) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Beijing Jingcheng Machinery Electric

What Is Beijing Jingcheng Machinery Electric's Net Debt?

As you can see below, Beijing Jingcheng Machinery Electric had CN¥190.5m of debt at September 2020, down from CN¥328.5m a year prior. However, because it has a cash reserve of CN¥180.0m, its net debt is less, at about CN¥10.5m.

How Healthy Is Beijing Jingcheng Machinery Electric's Balance Sheet?

The latest balance sheet data shows that Beijing Jingcheng Machinery Electric had liabilities of CN¥792.9m due within a year, and liabilities of CN¥78.5m falling due after that. Offsetting these obligations, it had cash of CN¥180.0m as well as receivables valued at CN¥226.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥464.6m.

While this might seem like a lot, it is not so bad since Beijing Jingcheng Machinery Electric has a market capitalization of CN¥1.77b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Carrying virtually no net debt, Beijing Jingcheng Machinery Electric has a very light debt load indeed. When analysing debt levels, the balance sheet is the obvious place to start. But it is Beijing Jingcheng Machinery Electric'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.

Over 12 months, Beijing Jingcheng Machinery Electric made a loss at the EBIT level, and saw its revenue drop to CN¥1.1b, which is a fall of 9.7%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Beijing Jingcheng Machinery Electric produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥100m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of CN¥102m into a profit. So we do think this stock is quite risky. 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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Beijing Jingcheng Machinery Electric you should know about.

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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