Daxin Materials (TWSE:5234) Seems To Use Debt Rather Sparingly

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, Daxin Materials Corporation (TWSE:5234) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Daxin Materials

How Much Debt Does Daxin Materials Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Daxin Materials had debt of NT$424.7m, up from NT$378.9m in one year. But on the other hand it also has NT$1.41b in cash, leading to a NT$987.6m net cash position.

How Strong Is Daxin Materials' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Daxin Materials had liabilities of NT$1.13b due within 12 months and liabilities of NT$435.6m due beyond that. Offsetting this, it had NT$1.41b in cash and NT$1.13b in receivables that were due within 12 months. So it can boast NT$983.4m more liquid assets than total liabilities.

This surplus suggests that Daxin Materials has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Daxin Materials has more cash than debt is arguably a good indication that it can manage its debt safely.

Daxin Materials's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 Daxin Materials 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Daxin Materials 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. During the last three years, Daxin Materials generated free cash flow amounting to a very robust 95% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Daxin Materials has net cash of NT$987.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$658m, being 95% of its EBIT. So is Daxin Materials's debt a risk? It doesn't seem so to us. 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 Daxin Materials has 3 warning signs (and 2 which are concerning) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.