Is Weichai Power (HKG:2338) A Risky Investment?

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. Importantly, Weichai Power Co., Ltd. (HKG:2338) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Weichai Power

What Is Weichai Power's Debt?

As you can see below, at the end of September 2022, Weichai Power had CN¥43.7b of debt, up from CN¥32.5b a year ago. Click the image for more detail. However, it does have CN¥82.3b in cash offsetting this, leading to net cash of CN¥38.7b.

How Strong Is Weichai Power's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Weichai Power had liabilities of CN¥126.1b due within 12 months and liabilities of CN¥67.1b due beyond that. On the other hand, it had cash of CN¥82.3b and CN¥51.0b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥59.9b.

This deficit isn't so bad because Weichai Power is worth a massive CN¥103.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Weichai Power boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Weichai Power's saving grace is its low debt levels, because its EBIT has tanked 81% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Weichai Power 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. 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. Happily for any shareholders, Weichai Power actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While Weichai Power does have more liabilities than liquid assets, it also has net cash of CN¥38.7b. And it impressed us with free cash flow of -CN¥3.4b, being 128% of its EBIT. So we don't have any problem with Weichai Power's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Weichai Power has 2 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.