Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Shengyi Electronics Co., Ltd. (SHSE:688183) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Shengyi Electronics Carry?
The image below, which you can click on for greater detail, shows that Shengyi Electronics had debt of CN¥1.04b at the end of March 2024, a reduction from CN¥1.39b over a year. However, it also had CN¥324.6m in cash, and so its net debt is CN¥716.3m.
How Healthy Is Shengyi Electronics' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Shengyi Electronics had liabilities of CN¥2.01b due within 12 months and liabilities of CN¥314.2m due beyond that. Offsetting this, it had CN¥324.6m in cash and CN¥1.16b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥848.0m.
Of course, Shengyi Electronics has a market capitalization of CN¥8.53b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But it is Shengyi Electronics'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.
Over 12 months, Shengyi Electronics saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.
Caveat Emptor
Over the last twelve months Shengyi Electronics produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥37m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥351m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. 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. We've identified 4 warning signs with Shengyi Electronics (at least 2 which are concerning) , 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.