The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Nanjing Tanker Corporation (SHSE:601975) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Nanjing Tanker Carry?
The chart below, which you can click on for greater detail, shows that Nanjing Tanker had CN¥1.53b in debt in March 2024; about the same as the year before. However, its balance sheet shows it holds CN¥3.89b in cash, so it actually has CN¥2.36b net cash.
How Healthy Is Nanjing Tanker's Balance Sheet?
The latest balance sheet data shows that Nanjing Tanker had liabilities of CN¥1.11b due within a year, and liabilities of CN¥1.63b falling due after that. On the other hand, it had cash of CN¥3.89b and CN¥1.01b worth of receivables due within a year. So it can boast CN¥2.17b more liquid assets than total liabilities.
This short term liquidity is a sign that Nanjing Tanker could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Nanjing Tanker boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Nanjing Tanker saw its EBIT decline by 3.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Nanjing Tanker's ability to maintain a healthy balance sheet going forward. 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. While Nanjing Tanker 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. Over the most recent three years, Nanjing Tanker recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While it is always sensible to investigate a company's debt, in this case Nanjing Tanker has CN¥2.36b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥1.6b, being 79% of its EBIT. So we don't think Nanjing Tanker's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Nanjing Tanker's earnings per share history for free.
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.