Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Longshine Technology Group Co., Ltd. (SZSE:300682) makes use of debt. But the more important question is: how much risk is that debt creating?
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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Longshine Technology Group
What Is Longshine Technology Group's Debt?
The image below, which you can click on for greater detail, shows that Longshine Technology Group had debt of CN¥506.5m at the end of September 2023, a reduction from CN¥1.07b over a year. But it also has CN¥1.55b in cash to offset that, meaning it has CN¥1.04b net cash.
How Strong Is Longshine Technology Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Longshine Technology Group had liabilities of CN¥1.55b due within 12 months and liabilities of CN¥360.3m due beyond that. On the other hand, it had cash of CN¥1.55b and CN¥3.97b worth of receivables due within a year. So it can boast CN¥3.61b more liquid assets than total liabilities.
This excess liquidity suggests that Longshine Technology Group is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Longshine Technology Group has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for Longshine Technology Group if management cannot prevent a repeat of the 70% 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 Longshine Technology Group'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Longshine Technology Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Longshine Technology Group created free cash flow amounting to 19% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Longshine Technology Group has net cash of CN¥1.04b, as well as more liquid assets than liabilities. So we don't have any problem with Longshine Technology Group's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 2 warning signs for Longshine Technology Group 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.