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. We can see that Ferrotec (An Hui) Technology Development Co.,LTD (SZSE:301297) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Ferrotec (An Hui) Technology DevelopmentLTD Carry?
You can click the graphic below for the historical numbers, but it shows that Ferrotec (An Hui) Technology DevelopmentLTD had CN¥35.1m of debt in September 2023, down from CN¥90.5m, one year before. However, it does have CN¥608.7m in cash offsetting this, leading to net cash of CN¥573.7m.
How Healthy Is Ferrotec (An Hui) Technology DevelopmentLTD's Balance Sheet?
The latest balance sheet data shows that Ferrotec (An Hui) Technology DevelopmentLTD had liabilities of CN¥187.1m due within a year, and liabilities of CN¥67.2m falling due after that. Offsetting these obligations, it had cash of CN¥608.7m as well as receivables valued at CN¥170.5m due within 12 months. So it can boast CN¥524.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Ferrotec (An Hui) Technology DevelopmentLTD could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Ferrotec (An Hui) Technology DevelopmentLTD has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, Ferrotec (An Hui) Technology DevelopmentLTD saw its EBIT drop by 9.2% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ferrotec (An Hui) Technology DevelopmentLTD's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Ferrotec (An Hui) Technology DevelopmentLTD 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. During the last three years, Ferrotec (An Hui) Technology DevelopmentLTD burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Ferrotec (An Hui) Technology DevelopmentLTD has net cash of CN¥573.7m, as well as more liquid assets than liabilities. So we don't have any problem with Ferrotec (An Hui) Technology DevelopmentLTD's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Ferrotec (An Hui) Technology DevelopmentLTD's earnings per share history for free.
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.