Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Jiangsu Jiangnan Water Co., Ltd. (SHSE:601199) makes use of debt. But should shareholders be worried about its use of debt?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Jiangsu Jiangnan Water
The image below, which you can click on for greater detail, shows that at June 2024 Jiangsu Jiangnan Water had debt of CN¥675.1m, up from CN¥633.8m in one year. However, its balance sheet shows it holds CN¥724.6m in cash, so it actually has CN¥49.6m net cash.
According to the last reported balance sheet, Jiangsu Jiangnan Water had liabilities of CN¥1.17b due within 12 months, and liabilities of CN¥1.14b due beyond 12 months. Offsetting these obligations, it had cash of CN¥724.6m as well as receivables valued at CN¥763.8m due within 12 months. So it has liabilities totalling CN¥828.3m more than its cash and near-term receivables, combined.
Of course, Jiangsu Jiangnan Water has a market capitalization of CN¥5.09b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Jiangsu Jiangnan Water also has more cash than debt, so we're pretty confident it can manage its debt safely.
But the other side of the story is that Jiangsu Jiangnan Water saw its EBIT decline by 5.7% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Jiangsu Jiangnan Water 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 company can only pay off debt with cold hard cash, not accounting profits. While Jiangsu Jiangnan Water 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. In the last three years, Jiangsu Jiangnan Water's free cash flow amounted to 28% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Although Jiangsu Jiangnan Water's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥49.6m. So we are not troubled with Jiangsu Jiangnan Water's debt use. 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, we've discovered 1 warning sign for Jiangsu Jiangnan Water that you should be aware of before investing here.
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.