Does China Railway Signal & Communication (HKG:3969) Have A 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.' 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. As with many other companies China Railway Signal & Communication Corporation Limited (HKG:3969) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for China Railway Signal & Communication

How Much Debt Does China Railway Signal & Communication Carry?

As you can see below, China Railway Signal & Communication had CN¥2.48b of debt at June 2021, down from CN¥2.99b a year prior. However, it does have CN¥21.6b in cash offsetting this, leading to net cash of CN¥19.1b.

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¥60.8b falling due within a year, and liabilities of CN¥3.20b due beyond that. Offsetting these obligations, it had cash of CN¥21.6b as well as receivables valued at CN¥60.6b due within 12 months. So it can boast CN¥18.2b more liquid assets than total liabilities.

This excess liquidity is a great indication that China Railway Signal & Communication's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, China Railway Signal & Communication boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that China Railway Signal & Communication grew its EBIT at 19% over the last year, further increasing its ability to manage debt. 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 China Railway Signal & Communication 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 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 20% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

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¥19.1b, as well as more liquid assets than liabilities. And we liked the look of last year's 19% year-on-year EBIT growth. So is China Railway Signal & Communication's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 1 warning sign for China Railway Signal & Communication that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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