These 4 metrics indicate that Weichai Power (HKG: 2338) is using debt reasonably well
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that Weichai Power Co., Ltd. (HKG: 2338) uses debt in his business. But the most important question is: what risk does this debt create?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, many companies use debt to finance their growth without negative consequences. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
Check out our latest review for Weichai Power
What is Weichai Power’s debt?
The graph below, which you can click for more details, shows Weichai Power owed CN 32.5 billion in debt as of September 2021; about the same as the year before. But he also has CN 76.1 billion in cash to compensate for this, which means he has CN 43.6 billion in net cash.
A look at the responsibilities of Weichai Power
We can see from the most recent balance sheet that Weichai Power had CN 130.8 billion liabilities due within one year and CN 60.5 billion liabilities due beyond. As compensation for these obligations, he had cash of CNS 76.1 billion as well as receivables valued at CN 62.4 billion due within 12 months. Thus, its liabilities total CNN 52.9 billion more than the combination of its cash and short-term receivables.
This deficit is not that big as Weichai Power is worth a whopping CN ¥ 148.6b, and therefore could possibly raise enough capital to consolidate its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky. Despite its notable liabilities, Weichai Power has a net cash flow, so it’s fair to say that it doesn’t have a heavy debt load!
Weichai Power’s EBIT was pretty stable over the past year, but that shouldn’t be a problem considering it doesn’t have a lot of debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Weichai Power can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. While Weichai Power has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it’s building ( or erodes) this cash balance. Over the past three years, Weichai Power has actually generated more free cash flow than EBIT. This kind of solid silver generation warms our hearts like a puppy in a bumblebee costume.
Although Weichai Power has more liabilities than liquid assets, it also has net cash of 43.6 billion yen. And he impressed us with a free cash flow of CN ¥ 19b, or 125% of his EBIT. So we have no problem with Weichai Power’s use of debt. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 2 warning signs for Weichai Power that you need to be aware of.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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