China Railway Signal & Communication (HKG:3969) Seems To Use Debt Rather Sparingly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies China Railway Signal & Communication Corporation Limited (HKG:3969) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China Railway Signal & Communication

What Is China Railway Signal & Communication's Net Debt?

As you can see below, at the end of September 2023, China Railway Signal & Communication had CN¥5.72b of debt, up from CN¥4.48b a year ago. Click the image for more detail. However, it does have CN¥20.1b in cash offsetting this, leading to net cash of CN¥14.4b.

A Look At China Railway Signal & Communication's Liabilities

We can see from the most recent balance sheet that China Railway Signal & Communication had liabilities of CN¥65.0b falling due within a year, and liabilities of CN¥3.97b due beyond that. Offsetting these obligations, it had cash of CN¥20.1b as well as receivables valued at CN¥67.6b due within 12 months. So it actually has CN¥18.8b 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. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that China Railway Signal & Communication has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that China Railway Signal & Communication grew its EBIT at 13% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Railway Signal & Communication 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. China Railway Signal & Communication 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. Looking at the most recent three years, China Railway Signal & Communication recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Railway Signal & Communication has CN¥14.4b in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 13% in the last twelve months. So we don't think China Railway Signal & Communication's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - China Railway Signal & Communication 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.