Is First Tractor (HKG:38) Using Debt In A Risky Way?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 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.

When Is Debt Dangerous?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out 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¥1.55b of debt in September 2020, down from CN¥2.11b, one year before. But on the other hand it also has CN¥2.34b in cash, leading to a CN¥787.4m 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¥7.27b due within 12 months and liabilities of CN¥469.6m due beyond that. On the other hand, it had cash of CN¥2.34b and CN¥3.23b worth of receivables due within a year. So its liabilities total CN¥2.17b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because First Tractor is worth CN¥7.06b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, First Tractor boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since First Tractor will need earnings to service that debt. 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.

Over 12 months, First Tractor reported revenue of CN¥7.1b, which is a gain of 20%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

So How Risky Is First Tractor?

Although First Tractor had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of CN¥469m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with First Tractor , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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