Weichai Power (HKG:2338) Seems To Use Debt Rather Sparingly

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.' 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. We can see that Weichai Power Co., Ltd. (HKG:2338) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Weichai Power

How Much Debt Does Weichai Power Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Weichai Power had CN¥45.9b of debt, an increase on CN¥43.7b, over one year. However, it does have CN¥93.2b in cash offsetting this, leading to net cash of CN¥47.3b.

How Strong Is Weichai Power's Balance Sheet?

We can see from the most recent balance sheet that Weichai Power had liabilities of CN¥142.0b falling due within a year, and liabilities of CN¥72.9b due beyond that. Offsetting these obligations, it had cash of CN¥93.2b as well as receivables valued at CN¥61.8b due within 12 months. So it has liabilities totalling CN¥59.9b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Weichai Power has a huge market capitalization of CN¥118.3b, 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. 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.

Better yet, Weichai Power grew its EBIT by 257% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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. Over the last three years, Weichai Power actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Weichai Power does have more liabilities than liquid assets, it also has net cash of CN¥47.3b. And it impressed us with free cash flow of CN¥14b, being 150% of its EBIT. So we don't think Weichai Power's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign 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.