Xinjiang Tianye Water Saving Irrigation System (HKG:840) Has Debt But No Earnings; Should You Worry?

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.' 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.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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

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

The image below, which you can click on for greater detail, shows that at June 2020 Xinjiang Tianye Water Saving Irrigation System had debt of CN¥80.0m, up from CN¥30.1m in one year. But on the other hand it also has CN¥120.7m in cash, leading to a CN¥40.7m net cash position.

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

We can see from the most recent balance sheet that Xinjiang Tianye Water Saving Irrigation System had liabilities of CN¥430.9m falling due within a year, and liabilities of CN¥10.7m due beyond that. Offsetting this, it had CN¥120.7m in cash and CN¥257.8m in receivables that were due within 12 months. So it has liabilities totalling CN¥63.0m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Xinjiang Tianye Water Saving Irrigation System has a market capitalization of CN¥138.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

In the last year Xinjiang Tianye Water Saving Irrigation System wasn't profitable at an EBIT level, but managed to grow its revenue by 13%, to CN¥694m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

So How Risky Is Xinjiang Tianye Water Saving Irrigation System?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months Xinjiang Tianye Water Saving Irrigation System lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥21m and booked a CN¥43m accounting loss. But at least it has CN¥40.7m on the balance sheet to spend on growth, near-term. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. 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. Case in point: We've spotted 2 warning signs for Xinjiang Tianye Water Saving Irrigation System you should be aware of, and 1 of them is a bit unpleasant.

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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