We Think Li Auto (NASDAQ:LI) Can Manage Its Debt With Ease

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Li Auto Inc. (NASDAQ:LI) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Li Auto

What Is Li Auto's Net Debt?

The image below, which you can click on for greater detail, shows that Li Auto had debt of CN¥7.90b at the end of September 2023, a reduction from CN¥9.49b over a year. However, its balance sheet shows it holds CN¥87.4b in cash, so it actually has CN¥79.5b net cash.

A Look At Li Auto's Liabilities

According to the last reported balance sheet, Li Auto had liabilities of CN¥57.7b due within 12 months, and liabilities of CN¥8.44b due beyond 12 months. Offsetting these obligations, it had cash of CN¥87.4b as well as receivables valued at CN¥86.8m due within 12 months. So it can boast CN¥21.3b more liquid assets than total liabilities.

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

It was also good to see that despite losing money on the EBIT line last year, Li Auto turned things around in the last 12 months, delivering and EBIT of CN¥4.2b. 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 Li Auto 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 company can only pay off debt with cold hard cash, not accounting profits. Li Auto 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 year, Li Auto actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Li Auto has CN¥79.5b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 774% of that EBIT to free cash flow, bringing in CN¥33b. So is Li Auto's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Li Auto is showing 1 warning sign in our investment analysis , you should know about...

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.