Weiqiao Textile (HKG:2698) Could Easily Take On More Debt

Simply Wall St
September 11, 2021
Source: Shutterstock

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 note that Weiqiao Textile Company Limited (HKG:2698) does have debt on its balance sheet. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Weiqiao Textile

What Is Weiqiao Textile's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Weiqiao Textile had debt of CN¥2.41b, up from CN¥2.06b in one year. However, its balance sheet shows it holds CN¥11.9b in cash, so it actually has CN¥9.49b net cash.

SEHK:2698 Debt to Equity History September 12th 2021

How Healthy Is Weiqiao Textile's Balance Sheet?

According to the last reported balance sheet, Weiqiao Textile had liabilities of CN¥5.45b due within 12 months, and liabilities of CN¥164.9m due beyond 12 months. On the other hand, it had cash of CN¥11.9b and CN¥640.9m worth of receivables due within a year. So it actually has CN¥6.92b more liquid assets than total liabilities.

This excess liquidity is a great indication that Weiqiao Textile's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Weiqiao Textile has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Weiqiao Textile grew its EBIT by 175% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is Weiqiao Textile'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Weiqiao Textile 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 three years, Weiqiao Textile 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 we empathize with investors who find debt concerning, the bottom line is that Weiqiao Textile has net cash of CN¥9.49b and plenty of liquid assets. The cherry on top was that in converted 163% of that EBIT to free cash flow, bringing in CN¥1.5b. At the end of the day we're not concerned about Weiqiao Textile's debt. 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. For instance, we've identified 3 warning signs for Weiqiao Textile (1 is concerning) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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