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 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 Ningbo Fuda Company Limited (SHSE:600724) makes use of debt. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Ningbo Fuda
The image below, which you can click on for greater detail, shows that Ningbo Fuda had debt of CN¥368.6m at the end of June 2024, a reduction from CN¥557.2m over a year. But it also has CN¥620.2m in cash to offset that, meaning it has CN¥251.7m net cash.
Zooming in on the latest balance sheet data, we can see that Ningbo Fuda had liabilities of CN¥661.9m due within 12 months and liabilities of CN¥127.5m due beyond that. On the other hand, it had cash of CN¥620.2m and CN¥299.1m worth of receivables due within a year. So it can boast CN¥129.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Ningbo Fuda could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Ningbo Fuda boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Ningbo Fuda if management cannot prevent a repeat of the 35% 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ningbo Fuda's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Ningbo Fuda 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. Looking at the most recent three years, Ningbo Fuda recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Ningbo Fuda has net cash of CN¥251.7m, as well as more liquid assets than liabilities. So we don't have any problem with Ningbo Fuda's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Ningbo Fuda (1 is potentially serious) you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.