Does Xuan Wu Cloud Technology Holdings (HKG:2392) Have A Healthy Balance Sheet?

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.' 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 can see that Xuan Wu Cloud Technology Holdings Limited (HKG:2392) does use debt in its business. But the more important question is: how much risk is that debt creating?

Our free stock report includes 2 warning signs investors should be aware of before investing in Xuan Wu Cloud Technology Holdings. Read for free now.

When Is Debt A Problem?

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. 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.

What Is Xuan Wu Cloud Technology Holdings's Debt?

The image below, which you can click on for greater detail, shows that Xuan Wu Cloud Technology Holdings had debt of CN¥144.0m at the end of December 2024, a reduction from CN¥157.2m over a year. However, it does have CN¥71.4m in cash offsetting this, leading to net debt of about CN¥72.6m.

How Strong Is Xuan Wu Cloud Technology Holdings' Balance Sheet?

We can see from the most recent balance sheet that Xuan Wu Cloud Technology Holdings had liabilities of CN¥297.7m falling due within a year, and liabilities of CN¥8.03m due beyond that. Offsetting this, it had CN¥71.4m in cash and CN¥304.0m in receivables that were due within 12 months. So it can boast CN¥69.6m more liquid assets than total liabilities.

This surplus suggests that Xuan Wu Cloud Technology Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

View our latest analysis for Xuan Wu Cloud Technology Holdings

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Xuan Wu Cloud Technology Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (16.8), and fairly weak interest coverage, since EBIT is just 0.59 times the interest expense. This means we'd consider it to have a heavy debt load. However, the silver lining was that Xuan Wu Cloud Technology Holdings achieved a positive EBIT of CN¥2.2m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Xuan Wu Cloud Technology Holdings will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Xuan Wu Cloud Technology Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Xuan Wu Cloud Technology Holdings's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its level of total liabilities is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Xuan Wu Cloud Technology Holdings stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. We've identified 2 warning signs with Xuan Wu Cloud Technology Holdings (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

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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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.