Is Shijiazhuang Tonhe Electronics TechnologiesLtd (SZSE:300491) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Shijiazhuang Tonhe Electronics Technologies Co.,Ltd. (SZSE:300491) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 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 Shijiazhuang Tonhe Electronics TechnologiesLtd

What Is Shijiazhuang Tonhe Electronics TechnologiesLtd's Net Debt?

As you can see below, at the end of September 2024, Shijiazhuang Tonhe Electronics TechnologiesLtd had CN¥222.4m of debt, up from CN¥190.1m a year ago. Click the image for more detail. On the flip side, it has CN¥169.6m in cash leading to net debt of about CN¥52.8m.

How Strong Is Shijiazhuang Tonhe Electronics TechnologiesLtd's Balance Sheet?

According to the last reported balance sheet, Shijiazhuang Tonhe Electronics TechnologiesLtd had liabilities of CN¥791.9m due within 12 months, and liabilities of CN¥68.9m due beyond 12 months. On the other hand, it had cash of CN¥169.6m and CN¥806.3m worth of receivables due within a year. So it can boast CN¥115.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Shijiazhuang Tonhe Electronics TechnologiesLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, Shijiazhuang Tonhe Electronics TechnologiesLtd has a very light debt load indeed.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shijiazhuang Tonhe Electronics TechnologiesLtd's net debt is only 0.73 times its EBITDA. And its EBIT easily covers its interest expense, being 15.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for Shijiazhuang Tonhe Electronics TechnologiesLtd if management cannot prevent a repeat of the 35% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shijiazhuang Tonhe Electronics TechnologiesLtd'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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Shijiazhuang Tonhe Electronics TechnologiesLtd 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.

Our View

Shijiazhuang Tonhe Electronics TechnologiesLtd's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. We think that Shijiazhuang Tonhe Electronics TechnologiesLtd's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example Shijiazhuang Tonhe Electronics TechnologiesLtd has 4 warning signs (and 1 which can't be ignored) we think you should know about.

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.