The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Niu Technologies (NASDAQ:NIU) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Niu Technologies Carry?
As you can see below, Niu Technologies had CN¥180.0m of debt at December 2020, down from CN¥217.4m a year prior. But on the other hand it also has CN¥1.10b in cash, leading to a CN¥923.1m net cash position.
How Strong Is Niu Technologies’ Balance Sheet?
The latest balance sheet data shows that Niu Technologies had liabilities of CN¥823.3m due within a year, and liabilities of CN¥30.2m falling due after that. On the other hand, it had cash of CN¥1.10b and CN¥103.6m worth of receivables due within a year. So it actually has CN¥353.3m more liquid assets than total liabilities.
This surplus suggests that Niu Technologies has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Niu Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, Niu Technologies saw its EBIT drop by 8.4% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Niu Technologies can strengthen its balance sheet over time.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Niu Technologies 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. Over the last two years, Niu Technologies recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company’s debt, in this case Niu Technologies has CN¥923.1m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in CN¥314m. So we don’t think Niu Technologies’s use of debt is risky. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it.