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 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. We can see that Keshun Waterproof Technolgies Co.,Ltd. (SZSE:300737) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Keshun Waterproof TechnolgiesLtd's Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Keshun Waterproof TechnolgiesLtd had debt of CN¥4.51b, up from CN¥2.61b in one year. However, because it has a cash reserve of CN¥2.93b, its net debt is less, at about CN¥1.57b.
How Healthy Is Keshun Waterproof TechnolgiesLtd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Keshun Waterproof TechnolgiesLtd had liabilities of CN¥5.24b due within 12 months and liabilities of CN¥3.01b due beyond that. Offsetting these obligations, it had cash of CN¥2.93b as well as receivables valued at CN¥5.41b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
Having regard to Keshun Waterproof TechnolgiesLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥5.26b company is struggling for cash, we still think it's worth monitoring its balance sheet.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Keshun Waterproof TechnolgiesLtd's net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its commanding EBIT of 2k times its interest expense, implies the debt load is as light as a peacock feather. Pleasingly, Keshun Waterproof TechnolgiesLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 226% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Keshun Waterproof TechnolgiesLtd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Keshun Waterproof TechnolgiesLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
Happily, Keshun Waterproof TechnolgiesLtd's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Keshun Waterproof TechnolgiesLtd can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Keshun Waterproof TechnolgiesLtd you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.