Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Xin Point Holdings Limited (HKG:1571) makes use of debt. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Xin Point Holdings Carry?
As you can see below, at the end of June 2019, Xin Point Holdings had CN¥7.64m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥502.9m in cash, so it actually has CN¥495.2m net cash.
A Look At Xin Point Holdings's Liabilities
Zooming in on the latest balance sheet data, we can see that Xin Point Holdings had liabilities of CN¥648.6m due within 12 months and liabilities of CN¥52.7m due beyond that. On the other hand, it had cash of CN¥502.9m and CN¥571.3m worth of receivables due within a year. So it actually has CN¥372.9m more liquid assets than total liabilities.
This luscious liquidity implies that Xin Point Holdings's balance sheet is sturdy like a giant sequoia tree. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Xin Point Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that Xin Point Holdings's load is not too heavy, because its EBIT was down 48% 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 ultimately the future profitability of the business will decide if Xin Point Holdings can strengthen its balance sheet over time. 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. Xin Point Holdings 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. Considering the last three years, Xin Point Holdings actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
While we empathize with investors who find debt concerning, you should keep in mind that Xin Point Holdings has net cash of CN¥495m, as well as more liquid assets than liabilities. So we are not troubled with Xin Point Holdings's debt use. We'd be motivated to research the stock further if we found out that Xin Point Holdings insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.