We Think China Railway Signal & Communication (HKG:3969) Can Stay On Top Of Its Debt

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 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?

When Is Debt A Problem?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for China Railway Signal & Communication

How Much Debt Does China Railway Signal & Communication Carry?

As you can see below, at the end of June 2023, China Railway Signal & Communication had CN¥6.19b of debt, up from CN¥3.95b a year ago. Click the image for more detail. But it also has CN¥22.3b in cash to offset that, meaning it has CN¥16.1b net cash.

A Look At China Railway Signal & Communication's Liabilities

The latest balance sheet data shows that China Railway Signal & Communication had liabilities of CN¥67.2b due within a year, and liabilities of CN¥4.04b falling due after that. On the other hand, it had cash of CN¥22.3b and CN¥66.2b worth of receivables due within a year. So it actually has CN¥17.2b 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. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, China Railway Signal & Communication boasts net cash, so it's fair to say it does not have a heavy debt load!

While China Railway Signal & Communication doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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. In the last three years, China Railway Signal & Communication's free cash flow amounted to 44% 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¥16.1b, as well as more liquid assets than liabilities. So is China Railway Signal & Communication's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for China Railway Signal & Communication you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.