XD (HKG:2400) 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.' 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 XD Inc. (HKG:2400) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for XD

How Much Debt Does XD Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 XD had CN¥1.69b of debt, an increase on none, over one year. However, it does have CN¥4.37b in cash offsetting this, leading to net cash of CN¥2.67b.

How Healthy Is XD's Balance Sheet?

We can see from the most recent balance sheet that XD had liabilities of CN¥733.9m falling due within a year, and liabilities of CN¥1.76b due beyond that. On the other hand, it had cash of CN¥4.37b and CN¥288.8m worth of receivables due within a year. So it can boast CN¥2.17b more liquid assets than total liabilities.

This surplus suggests that XD has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, XD boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if XD 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.

Over 12 months, XD made a loss at the EBIT level, and saw its revenue drop to CN¥2.8b, which is a fall of 6.2%. We would much prefer see growth.

So How Risky Is XD?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that XD had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of CN¥470m and booked a CN¥523m accounting loss. Given it only has net cash of CN¥2.67b, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that XD is showing 1 warning sign in our investment analysis , you should know about...

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.

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.