Is Xinjiang Tianye Water Saving Irrigation System (HKG:840) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Xinjiang Tianye Water Saving Irrigation System Company Limited (HKG:840) does carry debt. 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 Xinjiang Tianye Water Saving Irrigation System

What Is Xinjiang Tianye Water Saving Irrigation System's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Xinjiang Tianye Water Saving Irrigation System had CN¥53.1m of debt, an increase on CN¥31.0m, over one year. But it also has CN¥116.3m in cash to offset that, meaning it has CN¥63.3m net cash.

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

Zooming in on the latest balance sheet data, we can see that Xinjiang Tianye Water Saving Irrigation System had liabilities of CN¥354.2m due within 12 months and liabilities of CN¥10.8m due beyond that. Offsetting this, it had CN¥116.3m in cash and CN¥206.5m in receivables that were due within 12 months. So its liabilities total CN¥42.2m more than the combination of its cash and short-term receivables.

Xinjiang Tianye Water Saving Irrigation System has a market capitalization of CN¥114.1m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Xinjiang Tianye Water Saving Irrigation System also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Xinjiang Tianye Water Saving Irrigation System turned things around in the last 12 months, delivering and EBIT of CN¥8.7m. When analysing debt levels, the balance sheet is the obvious place to start. But it is Xinjiang Tianye Water Saving Irrigation System's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Xinjiang Tianye Water Saving Irrigation System may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Xinjiang Tianye Water Saving Irrigation System actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While Xinjiang Tianye Water Saving Irrigation System does have more liabilities than liquid assets, it also has net cash of CN¥63.3m. The cherry on top was that in converted 275% of that EBIT to free cash flow, bringing in CN¥24m. So we are not troubled with Xinjiang Tianye Water Saving Irrigation System's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. 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 3 warning signs for Xinjiang Tianye Water Saving Irrigation System 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. 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.
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