Is Xinyi Glass Holdings (HKG:868) A Risky Investment?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Xinyi Glass Holdings Limited (HKG:868) does use debt in its business. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Xinyi Glass Holdings

What Is Xinyi Glass Holdings's Debt?

As you can see below, Xinyi Glass Holdings had HK$7.10b of debt at June 2024, down from HK$12.9b a year prior. However, it does have HK$1.38b in cash offsetting this, leading to net debt of about HK$5.72b.

How Healthy Is Xinyi Glass Holdings' Balance Sheet?

The latest balance sheet data shows that Xinyi Glass Holdings had liabilities of HK$12.6b due within a year, and liabilities of HK$2.63b falling due after that. Offsetting this, it had HK$1.38b in cash and HK$3.26b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$10.6b.

While this might seem like a lot, it is not so bad since Xinyi Glass Holdings has a market capitalization of HK$29.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Xinyi Glass Holdings has a low net debt to EBITDA ratio of only 0.77. And its EBIT covers its interest expense a whopping 25.0 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Xinyi Glass Holdings has boosted its EBIT by 65%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Xinyi Glass Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Xinyi Glass Holdings produced sturdy free cash flow equating to 66% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Xinyi Glass Holdings's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think Xinyi Glass Holdings's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Xinyi Glass Holdings has 1 warning sign we think you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.