David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Xinhuanet Co., Ltd. (SHSE:603888) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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.
What Is Xinhuanet's Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Xinhuanet had debt of CN¥30.4m, up from none in one year. However, it does have CN¥3.18b in cash offsetting this, leading to net cash of CN¥3.15b.
How Strong Is Xinhuanet's Balance Sheet?
The latest balance sheet data shows that Xinhuanet had liabilities of CN¥999.9m due within a year, and liabilities of CN¥459.7m falling due after that. Offsetting this, it had CN¥3.18b in cash and CN¥393.7m in receivables that were due within 12 months. So it actually has CN¥2.11b more liquid assets than total liabilities.
This surplus suggests that Xinhuanet is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Xinhuanet boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Xinhuanet grew its EBIT by 180% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Xinhuanet will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Xinhuanet 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, Xinhuanet actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
While it is always sensible to investigate a company's debt, in this case Xinhuanet has CN¥3.15b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 267% of that EBIT to free cash flow, bringing in CN¥404m. The bottom line is that we do not find Xinhuanet's debt levels at all concerning. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Xinhuanet is showing 1 warning sign in our investment analysis , 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.