Here's Why Weichai Power (HKG:2338) Can Manage Its Debt Responsibly

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Weichai Power Co., Ltd. (HKG:2338) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Weichai Power

What Is Weichai Power's Net Debt?

As you can see below, at the end of March 2023, Weichai Power had CN¥47.3b of debt, up from CN¥29.1b a year ago. Click the image for more detail. But on the other hand it also has CN¥80.9b in cash, leading to a CN¥33.6b net cash position.

A Look At Weichai Power's Liabilities

According to the last reported balance sheet, Weichai Power had liabilities of CN¥129.7b due within 12 months, and liabilities of CN¥70.8b due beyond 12 months. Offsetting this, it had CN¥80.9b in cash and CN¥60.1b in receivables that were due within 12 months. So its liabilities total CN¥59.5b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Weichai Power has a huge market capitalization of CN¥103.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Weichai Power boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Weichai Power if management cannot prevent a repeat of the 48% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Weichai Power'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. Weichai Power 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. Over the last three years, Weichai Power actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Weichai Power does have more liabilities than liquid assets, it also has net cash of CN¥33.6b. The cherry on top was that in converted 115% of that EBIT to free cash flow, bringing in -CN¥6.0b. So we are not troubled with Weichai Power's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Weichai Power has 1 warning sign we think you should be aware of.

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.