Is First Tractor (HKG:38) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for First Tractor

What Is First Tractor's Net Debt?

The image below, which you can click on for greater detail, shows that First Tractor had debt of CN¥279.2m at the end of December 2023, a reduction from CN¥328.3m over a year. However, its balance sheet shows it holds CN¥3.63b in cash, so it actually has CN¥3.35b net cash.

A Look At First Tractor's Liabilities

We can see from the most recent balance sheet that First Tractor had liabilities of CN¥6.04b falling due within a year, and liabilities of CN¥553.3m due beyond that. Offsetting this, it had CN¥3.63b in cash and CN¥706.4m in receivables that were due within 12 months. So its liabilities total CN¥2.26b more than the combination of its cash and short-term receivables.

Given First Tractor has a market capitalization of CN¥16.1b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, First Tractor also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, First Tractor saw its EBIT drop by 7.4% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine First Tractor's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While First Tractor 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. Over the last three years, First Tractor actually produced more free cash flow than EBIT. 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 First Tractor does have more liabilities than liquid assets, it also has net cash of CN¥3.35b. And it impressed us with free cash flow of CN¥967m, being 273% of its EBIT. So we don't have any problem with First Tractor's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for First Tractor you should be aware of.

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. 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.