Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that China Isotope & Radiation Corporation (HKG:1763) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is China Isotope & Radiation's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 China Isotope & Radiation had CN¥249.4m of debt, an increase on CN¥150.0m, over one year. However, its balance sheet shows it holds CN¥2.33b in cash, so it actually has CN¥2.08b net cash.
A Look At China Isotope & Radiation's Liabilities
The latest balance sheet data shows that China Isotope & Radiation had liabilities of CN¥2.45b due within a year, and liabilities of CN¥361.8m falling due after that. On the other hand, it had cash of CN¥2.33b and CN¥1.95b worth of receivables due within a year. So it can boast CN¥1.47b more liquid assets than total liabilities.
This excess liquidity suggests that China Isotope & Radiation is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that China Isotope & Radiation has more cash than debt is arguably a good indication that it can manage its debt safely.
The good news is that China Isotope & Radiation has increased its EBIT by 6.9% over twelve months, which should ease any concerns about debt repayment. 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 China Isotope & Radiation'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. China Isotope & Radiation 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, China Isotope & Radiation reported free cash flow worth 6.4% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
While it is always sensible to investigate a company's debt, in this case China Isotope & Radiation has CN¥2.08b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 6.9% over the last year. So we don't think China Isotope & Radiation's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that China Isotope & Radiation is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...
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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