We Think Xinyi Electric Storage Holdings (HKG:8328) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Xinyi Electric Storage Holdings Limited (HKG:8328) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Xinyi Electric Storage Holdings

What Is Xinyi Electric Storage Holdings's Debt?

As you can see below, at the end of June 2021, Xinyi Electric Storage Holdings had HK$48.6m of debt, up from none a year ago. Click the image for more detail. However, it does have HK$101.6m in cash offsetting this, leading to net cash of HK$53.0m.

How Strong Is Xinyi Electric Storage Holdings' Balance Sheet?

We can see from the most recent balance sheet that Xinyi Electric Storage Holdings had liabilities of HK$187.5m falling due within a year, and liabilities of HK$542.0k due beyond that. Offsetting these obligations, it had cash of HK$101.6m as well as receivables valued at HK$111.1m due within 12 months. So it can boast HK$24.6m more liquid assets than total liabilities.

Having regard to Xinyi Electric Storage Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the HK$2.84b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Xinyi Electric Storage Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Xinyi Electric Storage Holdings has boosted its EBIT by 72%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Xinyi Electric Storage Holdings will need earnings to service that debt. 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. While Xinyi Electric Storage Holdings 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, Xinyi Electric Storage Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Xinyi Electric Storage Holdings has net cash of HK$53.0m, as well as more liquid assets than liabilities. And we liked the look of last year's 72% year-on-year EBIT growth. So we don't have any problem with Xinyi Electric Storage Holdings's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Xinyi Electric Storage Holdings you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.