Health Check: How Prudently Does Xinjiang Tianye Water Saving Irrigation System (HKG:840) Use Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Xinjiang Tianye Water Saving Irrigation System Company Limited (HKG:840) does use debt in its business. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. 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 Xinjiang Tianye Water Saving Irrigation System

How Much Debt Does Xinjiang Tianye Water Saving Irrigation System Carry?

The image below, which you can click on for greater detail, shows that at June 2022 Xinjiang Tianye Water Saving Irrigation System had debt of CN¥59.0m, up from CN¥33.6m in one year. But on the other hand it also has CN¥126.6m in cash, leading to a CN¥67.6m net cash position.

A Look At Xinjiang Tianye Water Saving Irrigation System's Liabilities

We can see from the most recent balance sheet that Xinjiang Tianye Water Saving Irrigation System had liabilities of CN¥386.6m falling due within a year, and liabilities of CN¥61.6m due beyond that. On the other hand, it had cash of CN¥126.6m and CN¥180.6m worth of receivables due within a year. So it has liabilities totalling CN¥140.9m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥109.6m, we think shareholders really should watch Xinjiang Tianye Water Saving Irrigation System's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Given that Xinjiang Tianye Water Saving Irrigation System has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Xinjiang Tianye Water Saving Irrigation System 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, Xinjiang Tianye Water Saving Irrigation System reported revenue of CN¥1.4b, which is a gain of 90%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Xinjiang Tianye Water Saving Irrigation System?

Although Xinjiang Tianye Water Saving Irrigation System had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥43m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. One positive was the revenue growth of 90% over the last year. But the stock still looks risky to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Xinjiang Tianye Water Saving Irrigation System (including 1 which is a bit concerning) .

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.