Xinyi Solar Holdings (HKG:968) Seems To Use Debt Quite Sensibly

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 Xinyi Solar Holdings Limited (HKG:968) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Xinyi Solar Holdings

What Is Xinyi Solar Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Xinyi Solar Holdings had HK$6.55b of debt in June 2021, down from HK$7.68b, one year before. However, it does have HK$10.6b in cash offsetting this, leading to net cash of HK$4.05b.

How Healthy Is Xinyi Solar Holdings' Balance Sheet?

We can see from the most recent balance sheet that Xinyi Solar Holdings had liabilities of HK$9.18b falling due within a year, and liabilities of HK$4.72b due beyond that. Offsetting these obligations, it had cash of HK$10.6b as well as receivables valued at HK$8.83b due within 12 months. So it actually has HK$5.53b more liquid assets than total liabilities.

This short term liquidity is a sign that Xinyi Solar Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Xinyi Solar Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Xinyi Solar Holdings grew its EBIT by 103% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Xinyi Solar 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Xinyi Solar Holdings 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. In the last three years, Xinyi Solar Holdings created free cash flow amounting to 9.7% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Xinyi Solar Holdings has HK$4.05b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 103% over the last year. So we don't think Xinyi Solar Holdings's use of debt is risky. 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 1 warning sign for Xinyi Solar Holdings that 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.

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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.
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