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.' 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. We note that China Isotope & Radiation Corporation (HKG:1763) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does China Isotope & Radiation Carry?
As you can see below, at the end of December 2021, China Isotope & Radiation had CN¥762.8m of debt, up from CN¥662.8m a year ago. Click the image for more detail. But on the other hand it also has CN¥2.90b in cash, leading to a CN¥2.14b net cash position.
How Strong Is China Isotope & Radiation's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that China Isotope & Radiation had liabilities of CN¥3.97b due within 12 months and liabilities of CN¥470.9m due beyond that. Offsetting these obligations, it had cash of CN¥2.90b as well as receivables valued at CN¥2.85b due within 12 months. So it actually has CN¥1.31b more liquid assets than total liabilities.
It's good to see that China Isotope & Radiation has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that China Isotope & Radiation has more cash than debt is arguably a good indication that it can manage its debt safely.
Another good sign is that China Isotope & Radiation has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Isotope & Radiation's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While China Isotope & Radiation has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, China Isotope & Radiation created free cash flow amounting to 11% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
While it is always sensible to investigate a company's debt, in this case China Isotope & Radiation has CN¥2.14b in net cash and a decent-looking balance sheet. And we liked the look of last year's 26% year-on-year EBIT growth. So is China Isotope & Radiation's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example China Isotope & Radiation has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
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.
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.