First Tractor (HKG:38) Seems To Use Debt Rather Sparingly

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, First Tractor Company Limited (HKG:38) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for First Tractor

What Is First Tractor's Net Debt?

You can click the graphic below for the historical numbers, but it shows that First Tractor had CN¥680.2m of debt in September 2021, down from CN¥1.57b, one year before. However, its balance sheet shows it holds CN¥4.91b in cash, so it actually has CN¥4.23b net cash.

How Strong Is First Tractor's Balance Sheet?

The latest balance sheet data shows that First Tractor had liabilities of CN¥6.59b due within a year, and liabilities of CN¥563.6m falling due after that. Offsetting these obligations, it had cash of CN¥4.91b as well as receivables valued at CN¥2.59b due within 12 months. So it actually has CN¥340.1m more liquid assets than total liabilities.

This surplus suggests that First Tractor has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, First Tractor boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that First Tractor grew its EBIT by 1,427% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is First Tractor's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Happily for any shareholders, First Tractor actually produced more free cash flow than EBIT over the last two years. 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 we empathize with investors who find debt concerning, you should keep in mind that First Tractor has net cash of CN¥4.23b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥1.9b, being 531% of its EBIT. So is First Tractor's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with First Tractor .

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.

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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.