Weichai Power (HKG:2338) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Weichai Power Co., Ltd. (HKG:2338) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Weichai Power

How Much Debt Does Weichai Power Carry?

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.

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¥129.7b due within 12 months and liabilities of CN¥70.8b due beyond that. Offsetting these obligations, it had cash of CN¥80.9b as well as receivables valued at CN¥60.1b due within 12 months. So it has liabilities totalling CN¥59.5b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its very significant market capitalization of CN¥98.5b, so it does suggest shareholders should keep an eye on Weichai Power's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Weichai Power also has more cash than debt, so we're pretty confident it can manage its debt safely.

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. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Weichai Power 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. Happily for any shareholders, Weichai Power actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Weichai Power's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it 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 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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Weichai Power .

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.