Is China Railway Signal & Communication (HKG:3969) A Risky Investment?

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.' 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. 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?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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 Net Debt?

As you can see below, at the end of March 2022, China Railway Signal & Communication had CN¥3.79b of debt, up from CN¥2.85b a year ago. Click the image for more detail. But it also has CN¥21.7b in cash to offset that, meaning it has CN¥18.0b net cash.

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

According to the last reported balance sheet, China Railway Signal & Communication had liabilities of CN¥58.3b due within 12 months, and liabilities of CN¥4.50b due beyond 12 months. Offsetting this, it had CN¥21.7b in cash and CN¥61.1b in receivables that were due within 12 months. So it can boast CN¥20.1b more liquid assets than total liabilities.

This luscious liquidity implies that China Railway Signal & Communication's balance sheet is sturdy like a giant sequoia tree. 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!

But the bad news is that China Railway Signal & Communication has seen its EBIT plunge 16% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 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 47% 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¥18.0b in net cash and a decent-looking balance sheet. So we don't have any problem with China Railway Signal & Communication's use of debt. 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. Be aware that China Railway Signal & Communication is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.