China Railway Signal & Communication (HKG:3969) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 China Railway Signal & Communication Corporation Limited (HKG:3969) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for China Railway Signal & Communication

How Much Debt Does China Railway Signal & Communication Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 China Railway Signal & Communication had CN¥4.48b of debt, an increase on CN¥2.64b, over one year. But it also has CN¥21.4b in cash to offset that, meaning it has CN¥16.9b net cash.

How Healthy Is China Railway Signal & Communication's Balance Sheet?

We can see from the most recent balance sheet that China Railway Signal & Communication had liabilities of CN¥63.0b falling due within a year, and liabilities of CN¥5.14b due beyond that. Offsetting these obligations, it had cash of CN¥21.4b as well as receivables valued at CN¥66.7b due within 12 months. So it actually has CN¥20.0b more liquid assets than total liabilities.

This surplus liquidity suggests that China Railway Signal & Communication's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, China Railway Signal & Communication boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that China Railway Signal & Communication saw its EBIT decline by 5.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China Railway Signal & Communication's ability to maintain a healthy balance sheet going forward. 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. While China Railway Signal & Communication 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. In the last three years, China Railway Signal & Communication's free cash flow amounted to 44% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Railway Signal & Communication has net cash of CN¥16.9b, as well as more liquid assets than liabilities. So we don't think China Railway Signal & Communication's use of debt is risky. 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 1 warning sign for China Railway Signal & Communication you should know about.

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.