Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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, Shenzhen TXD Technology Co.,Ltd. (SZSE:002845) does carry debt. But should shareholders be worried about its use of debt?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.
See our latest analysis for Shenzhen TXD TechnologyLtd
You can click the graphic below for the historical numbers, but it shows that as of June 2024 Shenzhen TXD TechnologyLtd had CN¥1.48b of debt, an increase on CN¥934.0m, over one year. However, it does have CN¥1.36b in cash offsetting this, leading to net debt of about CN¥120.2m.
The latest balance sheet data shows that Shenzhen TXD TechnologyLtd had liabilities of CN¥5.11b due within a year, and liabilities of CN¥956.5m falling due after that. Offsetting this, it had CN¥1.36b in cash and CN¥2.87b in receivables that were due within 12 months. So its liabilities total CN¥1.84b more than the combination of its cash and short-term receivables.
Shenzhen TXD TechnologyLtd has a market capitalization of CN¥4.62b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Given net debt is only 0.52 times EBITDA, it is initially surprising to see that Shenzhen TXD TechnologyLtd's EBIT has low interest coverage of 0.58 times. So one way or the other, it's clear the debt levels are not trivial. Notably, Shenzhen TXD TechnologyLtd made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥28m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shenzhen TXD TechnologyLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Shenzhen TXD TechnologyLtd actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Based on what we've seen Shenzhen TXD TechnologyLtd is not finding it easy, given its interest cover, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. Considering this range of data points, we think Shenzhen TXD TechnologyLtd is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For example, we've discovered 2 warning signs for Shenzhen TXD TechnologyLtd (1 is potentially serious!) that you should be aware of before investing here.
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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.