David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Jiangsu Dingsheng New Materials Joint-Stock Co.,Ltd (SHSE:603876) makes use of debt. But is this debt a concern to shareholders?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Jiangsu Dingsheng New Materials Ltd's Debt?
As you can see below, at the end of September 2023, Jiangsu Dingsheng New Materials Ltd had CN¥7.17b of debt, up from CN¥6.34b a year ago. Click the image for more detail. But it also has CN¥8.43b in cash to offset that, meaning it has CN¥1.26b net cash.
How Strong Is Jiangsu Dingsheng New Materials Ltd's Balance Sheet?
We can see from the most recent balance sheet that Jiangsu Dingsheng New Materials Ltd had liabilities of CN¥14.8b falling due within a year, and liabilities of CN¥2.90b due beyond that. Offsetting these obligations, it had cash of CN¥8.43b as well as receivables valued at CN¥3.59b due within 12 months. So it has liabilities totalling CN¥5.71b more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of CN¥8.15b, so it does suggest shareholders should keep an eye on Jiangsu Dingsheng New Materials Ltd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Jiangsu Dingsheng New Materials Ltd boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Jiangsu Dingsheng New Materials Ltd if management cannot prevent a repeat of the 41% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Jiangsu Dingsheng New Materials Ltd'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Jiangsu Dingsheng New Materials Ltd 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. In the last three years, Jiangsu Dingsheng New Materials Ltd's free cash flow amounted to 41% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
Although Jiangsu Dingsheng New Materials Ltd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥1.26b. So although we see some areas for improvement, we're not too worried about Jiangsu Dingsheng New Materials Ltd's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Jiangsu Dingsheng New Materials Ltd , and understanding them should be part of your investment process.
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.