Is Xiaomi (HKG:1810) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Xiaomi

What Is Xiaomi's Net Debt?

As you can see below, Xiaomi had CN¥25.8b of debt, at September 2022, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥66.5b in cash to offset that, meaning it has CN¥40.7b net cash.

How Strong Is Xiaomi's Balance Sheet?

We can see from the most recent balance sheet that Xiaomi had liabilities of CN¥94.1b falling due within a year, and liabilities of CN¥42.2b due beyond that. Offsetting this, it had CN¥66.5b in cash and CN¥21.2b in receivables that were due within 12 months. So it has liabilities totalling CN¥48.6b more than its cash and near-term receivables, combined.

Of course, Xiaomi has a titanic market capitalization of CN¥252.7b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Xiaomi boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Xiaomi's saving grace is its low debt levels, because its EBIT has tanked 58% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 company can only pay off debt with cold hard cash, not accounting profits. While Xiaomi 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. During the last three years, Xiaomi produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Xiaomi does have more liabilities than liquid assets, it also has net cash of CN¥40.7b. So we don't have any problem with Xiaomi's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Xiaomi 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.

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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.