Does China Railway Signal & Communication (HKG:3969) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that China Railway Signal & Communication Corporation Limited (HKG:3969) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for China Railway Signal & Communication

What Is China Railway Signal & Communication's Debt?

As you can see below, at the end of December 2023, China Railway Signal & Communication had CN¥5.77b of debt, up from CN¥4.70b a year ago. Click the image for more detail. But it also has CN¥22.6b in cash to offset that, meaning it has CN¥16.8b net cash.

A Look At China Railway Signal & Communication's Liabilities

According to the last reported balance sheet, China Railway Signal & Communication had liabilities of CN¥66.2b due within 12 months, and liabilities of CN¥3.87b due beyond 12 months. Offsetting these obligations, it had cash of CN¥22.6b as well as receivables valued at CN¥64.7b due within 12 months. So it actually has CN¥17.1b 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. Succinctly put, China Railway Signal & Communication boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, China Railway Signal & Communication saw its EBIT drop by 2.9% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. 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 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. Looking at the most recent three years, China Railway Signal & Communication recorded free cash flow of 40% 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¥16.8b in net cash and a decent-looking balance sheet. 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. Case in point: We've spotted 1 warning sign for China Railway Signal & Communication you should be aware of.

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.