We Think China Motor (TWSE:2204) 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, China Motor Corporation (TWSE:2204) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for China Motor

What Is China Motor's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 China Motor had NT$4.09b of debt, an increase on NT$1.67b, over one year. But on the other hand it also has NT$4.67b in cash, leading to a NT$580.3m net cash position.

A Look At China Motor's Liabilities

We can see from the most recent balance sheet that China Motor had liabilities of NT$12.5b falling due within a year, and liabilities of NT$1.11b due beyond that. Offsetting this, it had NT$4.67b in cash and NT$3.21b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$5.76b.

Given China Motor has a market capitalization of NT$45.3b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, China Motor boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, China Motor grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its 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 Motor 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, a company can only pay off debt with cold hard cash, not accounting profits. China Motor 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. Over the last three years, China Motor reported free cash flow worth 11% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

Although China Motor's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$580.3m. And we liked the look of last year's 32% year-on-year EBIT growth. So we don't have any problem with China Motor'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. We've identified 1 warning sign with China Motor , and understanding them should be part of your investment process.

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.

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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.