Health Check: How Prudently Does Xinjiang Tianye Water Saving Irrigation System (HKG:840) Use 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. We note that Xinjiang Tianye Water Saving Irrigation System Company Limited (HKG:840) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at 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 2023 Xinjiang Tianye Water Saving Irrigation System had debt of CN¥76.6m, up from CN¥59.0m in one year. But on the other hand it also has CN¥196.2m in cash, leading to a CN¥119.6m net cash position.

How Healthy Is Xinjiang Tianye Water Saving Irrigation System's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Xinjiang Tianye Water Saving Irrigation System had liabilities of CN¥664.8m due within 12 months and liabilities of CN¥57.0m due beyond that. On the other hand, it had cash of CN¥196.2m and CN¥228.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥296.7m.

The deficiency here weighs heavily on the CN¥77.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Xinjiang Tianye Water Saving Irrigation System would likely require a major re-capitalisation if it had to pay its creditors today. Xinjiang Tianye Water Saving Irrigation System boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Xinjiang Tianye Water Saving Irrigation System reported revenue of CN¥1.7b, which is a gain of 21%, 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?

While Xinjiang Tianye Water Saving Irrigation System lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥30m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. One positive was the revenue growth of 21% over the last year. But we genuinely do think the balance sheet is a risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Xinjiang Tianye Water Saving Irrigation System (of which 1 is a bit unpleasant!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.