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.' 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 Sinoma International Engineering Co.,Ltd (SHSE:600970) makes use of 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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Sinoma International EngineeringLtd
As you can see below, Sinoma International EngineeringLtd had CN¥6.17b of debt at September 2024, down from CN¥7.38b a year prior. But it also has CN¥6.34b in cash to offset that, meaning it has CN¥164.8m net cash.
We can see from the most recent balance sheet that Sinoma International EngineeringLtd had liabilities of CN¥29.4b falling due within a year, and liabilities of CN¥4.62b due beyond that. On the other hand, it had cash of CN¥6.34b and CN¥22.6b worth of receivables due within a year. So its liabilities total CN¥5.14b more than the combination of its cash and short-term receivables.
Since publicly traded Sinoma International EngineeringLtd shares are worth a total of CN¥27.1b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Sinoma International EngineeringLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Sinoma International EngineeringLtd grew its EBIT by 14% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sinoma International EngineeringLtd's ability to maintain a healthy balance sheet going forward. 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. Sinoma International EngineeringLtd 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. In the last three years, Sinoma International EngineeringLtd's free cash flow amounted to 42% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Although Sinoma International EngineeringLtd'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¥164.8m. On top of that, it increased its EBIT by 14% in the last twelve months. So we are not troubled with Sinoma International EngineeringLtd's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Sinoma International EngineeringLtd you should be aware of.
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.
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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.