Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies China Railway Signal & Communication Corporation Limited (HKG:3969) makes use of debt. 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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is China Railway Signal & Communication's Net Debt?
You can click the graphic below for the historical numbers, but it shows that China Railway Signal & Communication had CN¥3.59b of debt in December 2024, down from CN¥5.77b, one year before. But on the other hand it also has CN¥22.6b in cash, leading to a CN¥19.0b net cash position.
How Healthy Is China Railway Signal & Communication's Balance Sheet?
According to the last reported balance sheet, China Railway Signal & Communication had liabilities of CN¥63.2b due within 12 months, and liabilities of CN¥4.23b due beyond 12 months. On the other hand, it had cash of CN¥22.6b and CN¥62.9b worth of receivables due within a year. So it actually has CN¥18.1b more liquid assets than total liabilities.
This surplus strongly suggests that China Railway Signal & Communication has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that China Railway Signal & Communication has more cash than debt is arguably a good indication that it can manage its debt safely.
Check out our latest analysis for China Railway Signal & Communication
China Railway Signal & Communication's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China Railway Signal & Communication's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts .
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China Railway Signal & Communication 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 most recent three years, China Railway Signal & Communication recorded free cash flow worth 60% 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 China Railway Signal & Communication has CN¥19.0b in net cash and a decent-looking balance sheet. So we don't think China Railway Signal & Communication's use of debt is risky. 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. Be aware that China Railway Signal & Communication is showing 1 warning sign in our investment analysis , you should know about...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.