Xiaomi (HKG:1810) Could Easily Take On More Debt

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Xiaomi Corporation (HKG:1810) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Xiaomi

What Is Xiaomi's Debt?

As you can see below, at the end of June 2024, Xiaomi had CN¥30.0b of debt, up from CN¥22.9b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥97.8b in cash, so it actually has CN¥67.8b net cash.

How Strong Is Xiaomi's Balance Sheet?

The latest balance sheet data shows that Xiaomi had liabilities of CN¥126.0b due within a year, and liabilities of CN¥43.0b falling due after that. Offsetting this, it had CN¥97.8b in cash and CN¥24.7b in receivables that were due within 12 months. So it has liabilities totalling CN¥46.5b more than its cash and near-term receivables, combined.

Of course, Xiaomi has a titanic market capitalization of CN¥448.0b, 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. Despite its noteworthy liabilities, Xiaomi boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Xiaomi grew its EBIT by 133% over twelve months. That boost will make it even easier to pay down debt going forward. 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 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. 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. In the last three years, Xiaomi's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Xiaomi's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥67.8b. And we liked the look of last year's 133% year-on-year EBIT growth. So we don't think Xiaomi's use of debt is risky. 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. For example - Xiaomi has 1 warning sign 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.