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.' 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, Wangsu Science & Technology Co.,Ltd. (SZSE:300017) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Wangsu Science & TechnologyLtd
What Is Wangsu Science & TechnologyLtd's Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Wangsu Science & TechnologyLtd had debt of CN¥279.6m, up from CN¥50.1m in one year. But on the other hand it also has CN¥5.15b in cash, leading to a CN¥4.87b net cash position.
How Strong Is Wangsu Science & TechnologyLtd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Wangsu Science & TechnologyLtd had liabilities of CN¥1.55b due within 12 months and liabilities of CN¥76.4m due beyond that. On the other hand, it had cash of CN¥5.15b and CN¥1.13b worth of receivables due within a year. So it actually has CN¥4.66b more liquid assets than total liabilities.
This excess liquidity suggests that Wangsu Science & TechnologyLtd is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Wangsu Science & TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, Wangsu Science & TechnologyLtd grew its EBIT by 1,236% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Wangsu Science & TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Wangsu Science & TechnologyLtd 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. Happily for any shareholders, Wangsu Science & TechnologyLtd actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Wangsu Science & TechnologyLtd has net cash of CN¥4.87b, as well as more liquid assets than liabilities. The cherry on top was that in converted 486% of that EBIT to free cash flow, bringing in CN¥1.0b. When it comes to Wangsu Science & TechnologyLtd's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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 Wangsu Science & TechnologyLtd has 2 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.