Weichai Power (HKG:2338) Seems To Use Debt Rather Sparingly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Weichai Power Co., Ltd. (HKG:2338) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Weichai Power's Net Debt?

As you can see below, Weichai Power had CN¥39.9b of debt at September 2024, down from CN¥45.9b a year prior. But it also has CN¥83.1b in cash to offset that, meaning it has CN¥43.2b net cash.

A Look At Weichai Power's Liabilities

We can see from the most recent balance sheet that Weichai Power had liabilities of CN¥151.6b falling due within a year, and liabilities of CN¥71.0b due beyond that. Offsetting these obligations, it had cash of CN¥83.1b as well as receivables valued at CN¥62.6b due within 12 months. So its liabilities total CN¥76.9b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Weichai Power has a huge market capitalization of CN¥141.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Weichai Power also has more cash than debt, so we're pretty confident it can manage its debt safely.

Check out our latest analysis for Weichai Power

In addition to that, we're happy to report that Weichai Power has boosted its EBIT by 54%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Weichai Power'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. While Weichai Power 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. During the last three years, Weichai Power generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Weichai Power's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥43.2b. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in CN¥13b. So we don't think Weichai Power'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 Weichai Power 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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