Is Ruijie Networks (SZSE:301165) A Risky Investment?

Simply Wall St · 11/25 22:54

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Ruijie Networks Co., Ltd. (SZSE:301165) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for Ruijie Networks

What Is Ruijie Networks's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Ruijie Networks had debt of CN¥1.30b, up from CN¥600.0m in one year. However, its balance sheet shows it holds CN¥1.64b in cash, so it actually has CN¥334.5m net cash.

debt-equity-history-analysis
SZSE:301165 Debt to Equity History November 25th 2024

How Strong Is Ruijie Networks' Balance Sheet?

We can see from the most recent balance sheet that Ruijie Networks had liabilities of CN¥4.64b falling due within a year, and liabilities of CN¥144.3m due beyond that. Offsetting these obligations, it had cash of CN¥1.64b as well as receivables valued at CN¥1.68b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.47b.

Of course, Ruijie Networks has a market capitalization of CN¥27.8b, 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. Despite its noteworthy liabilities, Ruijie Networks boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Ruijie Networks grew its EBIT by 374% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Ruijie Networks'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 company can only pay off debt with cold hard cash, not accounting profits. Ruijie Networks may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Ruijie Networks saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ruijie Networks has CN¥334.5m in net cash. And we liked the look of last year's 374% year-on-year EBIT growth. So we are not troubled with Ruijie Networks's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Ruijie Networks (of which 1 doesn't sit too well with us!) 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.