David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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 note that Xtep International Holdings Limited (HKG:1368) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Xtep International Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Xtep International Holdings had CN¥1.78b of debt in June 2019, down from CN¥1.98b, one year before. However, it does have CN¥5.03b in cash offsetting this, leading to net cash of CN¥3.24b.
A Look At Xtep International Holdings's Liabilities
Zooming in on the latest balance sheet data, we can see that Xtep International Holdings had liabilities of CN¥3.46b due within 12 months and liabilities of CN¥320.7m due beyond that. Offsetting this, it had CN¥5.03b in cash and CN¥2.26b in receivables that were due within 12 months. So it actually has CN¥3.51b more liquid assets than total liabilities.
This surplus liquidity suggests that Xtep International Holdings's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Xtep International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Another good sign is that Xtep International Holdings has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Xtep International Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Xtep International Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Xtep International Holdings's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Xtep International Holdings has net cash of CN¥3.24b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 24% over the last year. So is Xtep International Holdings's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Xtep International Holdings would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.