Is China Railway Signal & Communication (HKG:3969) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, China Railway Signal & Communication Corporation Limited (HKG:3969) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for China Railway Signal & Communication

What Is China Railway Signal & Communication's Debt?

As you can see below, China Railway Signal & Communication had CN¥2.64b of debt at September 2021, down from CN¥2.91b a year prior. But on the other hand it also has CN¥17.1b in cash, leading to a CN¥14.5b net cash position.

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

According to the last reported balance sheet, China Railway Signal & Communication had liabilities of CN¥60.3b due within 12 months, and liabilities of CN¥3.39b due beyond 12 months. On the other hand, it had cash of CN¥17.1b and CN¥62.0b worth of receivables due within a year. So it can boast CN¥15.4b 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. 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!

But the other side of the story is that China Railway Signal & Communication saw its EBIT decline by 3.0% 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 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 28% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case China Railway Signal & Communication has CN¥14.5b 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for China Railway Signal & Communication that you should be aware of before investing here.

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.

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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