These 4 Measures Indicate That China Railway Signal & Communication (HKG:3969) Is Using Debt Safely

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. 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.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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

How Much Debt Does China Railway Signal & Communication Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 China Railway Signal & Communication had CN¥5.80b of debt, an increase on CN¥3.79b, over one year. However, it does have CN¥21.8b in cash offsetting this, leading to net cash of CN¥16.0b.

A Look At China Railway Signal & Communication's Liabilities

Zooming in on the latest balance sheet data, we can see that China Railway Signal & Communication had liabilities of CN¥64.2b due within 12 months and liabilities of CN¥4.29b due beyond that. Offsetting these obligations, it had cash of CN¥21.8b as well as receivables valued at CN¥65.8b due within 12 months. So it actually has CN¥19.2b more liquid assets than total liabilities.

This surplus strongly suggests that China Railway Signal & Communication has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 38% of its EBIT, less 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¥16.0b 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. 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 - China Railway Signal & Communication has 1 warning sign we think you should be aware of.

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.