First Tractor (HKG:38) Could Easily Take On More Debt

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 First Tractor Company Limited (HKG:38) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for First Tractor

How Much Debt Does First Tractor Carry?

The image below, which you can click on for greater detail, shows that First Tractor had debt of CN¥595.0m at the end of March 2021, a reduction from CN¥1.99b over a year. But on the other hand it also has CN¥3.49b in cash, leading to a CN¥2.89b net cash position.

A Look At First Tractor's Liabilities

Zooming in on the latest balance sheet data, we can see that First Tractor had liabilities of CN¥6.31b due within 12 months and liabilities of CN¥483.8m due beyond that. Offsetting these obligations, it had cash of CN¥3.49b as well as receivables valued at CN¥2.87b due within 12 months. So it has liabilities totalling CN¥441.1m more than its cash and near-term receivables, combined.

Of course, First Tractor has a market capitalization of CN¥10.9b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, First Tractor boasts net cash, so it's fair to say it does not have a heavy debt load!

Although First Tractor made a loss at the EBIT level, last year, it was also good to see that it generated CN¥455m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is First Tractor's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. First Tractor 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 year, First Tractor actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that First Tractor has CN¥2.89b in net cash. And it impressed us with free cash flow of CN¥1.4b, being 307% of its EBIT. So we don't think First Tractor'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. Be aware that First Tractor is showing 3 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

If you're looking for stocks to buy, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.