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. As with many other companies Xiaomi Corporation (HKG:1810) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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?

As you can see below, Xiaomi had CN¥22.5b of debt at March 2023, down from CN¥29.7b a year prior. However, its balance sheet shows it holds CN¥71.2b in cash, so it actually has CN¥48.8b net cash.

How Strong Is Xiaomi's Balance Sheet?

We can see from the most recent balance sheet that Xiaomi had liabilities of CN¥76.0b falling due within a year, and liabilities of CN¥39.8b due beyond that. Offsetting these obligations, it had cash of CN¥71.2b as well as receivables valued at CN¥17.8b due within 12 months. So it has liabilities totalling CN¥26.8b more than its cash and near-term receivables, combined.

Of course, Xiaomi has a titanic market capitalization of CN¥262.1b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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.

In fact Xiaomi's saving grace is its low debt levels, because its EBIT has tanked 65% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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'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. 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. During the last three years, Xiaomi produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Xiaomi does have more liabilities than liquid assets, it also has net cash of CN¥48.8b. So we don't have any problem with Xiaomi's use of debt. 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. Case in point: We've spotted 1 warning sign for Xiaomi you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.