Is Zhuzhou CRRC Times Electric (HKG:3898) Using Too Much Debt?

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 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 Zhuzhou CRRC Times Electric Co., Ltd. (HKG:3898) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Zhuzhou CRRC Times Electric

How Much Debt Does Zhuzhou CRRC Times Electric Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Zhuzhou CRRC Times Electric had CN¥410.0m of debt, an increase on CN¥392.6m, over one year. But it also has CN¥13.5b in cash to offset that, meaning it has CN¥13.1b net cash.

How Strong Is Zhuzhou CRRC Times Electric's Balance Sheet?

We can see from the most recent balance sheet that Zhuzhou CRRC Times Electric had liabilities of CN¥11.3b falling due within a year, and liabilities of CN¥1.47b due beyond that. On the other hand, it had cash of CN¥13.5b and CN¥14.7b worth of receivables due within a year. So it can boast CN¥15.5b more liquid assets than total liabilities.

This excess liquidity suggests that Zhuzhou CRRC Times Electric is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Zhuzhou CRRC Times Electric boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Zhuzhou CRRC Times Electric saw its EBIT decline by 4.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhuzhou CRRC Times Electric's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Zhuzhou CRRC Times Electric 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 most recent three years, Zhuzhou CRRC Times Electric recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhuzhou CRRC Times Electric has CN¥13.1b in net cash and a decent-looking balance sheet. So we don't think Zhuzhou CRRC Times Electric's use of debt is risky. 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. Be aware that Zhuzhou CRRC Times Electric is showing 1 warning sign in our investment analysis , you should know about...

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.