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.' 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. Importantly, Sineng Electric Co.,Ltd. (SZSE:300827) does carry debt. But should shareholders be worried about its use of debt?
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. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Sineng ElectricLtd
As you can see below, at the end of September 2024, Sineng ElectricLtd had CN¥1.76b of debt, up from CN¥839.0m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.89b in cash, leading to a CN¥130.1m net cash position.
The latest balance sheet data shows that Sineng ElectricLtd had liabilities of CN¥5.21b due within a year, and liabilities of CN¥180.8m falling due after that. Offsetting this, it had CN¥1.89b in cash and CN¥3.02b in receivables that were due within 12 months. So its liabilities total CN¥479.2m more than the combination of its cash and short-term receivables.
Since publicly traded Sineng ElectricLtd shares are worth a total of CN¥16.8b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Sineng ElectricLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Sineng ElectricLtd grew its EBIT by 69% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Sineng ElectricLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sineng ElectricLtd 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. Over the last three years, Sineng ElectricLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
We could understand if investors are concerned about Sineng ElectricLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥130.1m. And it impressed us with its EBIT growth of 69% over the last year. So we are not troubled with Sineng ElectricLtd's debt use. 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. Case in point: We've spotted 2 warning signs for Sineng ElectricLtd you should be aware of, and 1 of them is a bit unpleasant.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.