Is Xiaomi (HKG:1810) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Xiaomi Corporation (HKG:1810) does carry debt. But should shareholders be worried about its use of debt?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Xiaomi

How Much Debt Does Xiaomi Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Xiaomi had CN¥26.2b of debt, an increase on CN¥17.6b, over one year. But it also has CN¥86.2b in cash to offset that, meaning it has CN¥59.9b net cash.

A Look At Xiaomi's Liabilities

Zooming in on the latest balance sheet data, we can see that Xiaomi had liabilities of CN¥115.7b due within 12 months and liabilities of CN¥39.7b due beyond that. On the other hand, it had cash of CN¥86.2b and CN¥23.1b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥46.2b.

Of course, Xiaomi has a titanic market capitalization of CN¥265.3b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Xiaomi also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Xiaomi grew its EBIT by 93% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Xiaomi can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Xiaomi 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. Happily for any shareholders, Xiaomi actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While Xiaomi does have more liabilities than liquid assets, it also has net cash of CN¥59.9b. And it impressed us with free cash flow of CN¥9.8b, being 140% of its EBIT. So is Xiaomi's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Xiaomi has 2 warning signs we think 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.