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. We note that Nanjing Xinjiekou Department Store Co., Ltd. (SHSE:600682) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Nanjing Xinjiekou Department Store's Net Debt?
The image below, which you can click on for greater detail, shows that Nanjing Xinjiekou Department Store had debt of CN¥870.6m at the end of September 2023, a reduction from CN¥907.3m over a year. But on the other hand it also has CN¥5.63b in cash, leading to a CN¥4.76b net cash position.
A Look At Nanjing Xinjiekou Department Store's Liabilities
Zooming in on the latest balance sheet data, we can see that Nanjing Xinjiekou Department Store had liabilities of CN¥5.92b due within 12 months and liabilities of CN¥1.08b due beyond that. Offsetting this, it had CN¥5.63b in cash and CN¥1.38b in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.
Having regard to Nanjing Xinjiekou Department Store's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥7.91b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Nanjing Xinjiekou Department Store has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for Nanjing Xinjiekou Department Store if management cannot prevent a repeat of the 33% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Nanjing Xinjiekou Department Store 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Nanjing Xinjiekou Department Store 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. Happily for any shareholders, Nanjing Xinjiekou Department Store actually produced more free cash flow than EBIT over the last three years. 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 Nanjing Xinjiekou Department Store has CN¥4.76b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥699m, being 107% of its EBIT. So we don't have any problem with Nanjing Xinjiekou Department Store's use of debt. 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 Nanjing Xinjiekou Department Store is showing 1 warning sign in our investment analysis , 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.