Is Dong Feng Electronic TechnologyLtd (SHSE:600081) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Dong Feng Electronic Technology Co.,Ltd. (SHSE:600081) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Dong Feng Electronic TechnologyLtd

What Is Dong Feng Electronic TechnologyLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Dong Feng Electronic TechnologyLtd had CN¥441.5m of debt in September 2024, down from CN¥745.8m, one year before. But on the other hand it also has CN¥3.24b in cash, leading to a CN¥2.80b net cash position.

How Healthy Is Dong Feng Electronic TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Dong Feng Electronic TechnologyLtd had liabilities of CN¥4.03b falling due within a year, and liabilities of CN¥235.6m due beyond that. Offsetting this, it had CN¥3.24b in cash and CN¥2.54b in receivables that were due within 12 months. So it actually has CN¥1.50b more liquid assets than total liabilities.

This excess liquidity suggests that Dong Feng Electronic 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, Dong Feng Electronic TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Dong Feng Electronic TechnologyLtd grew its EBIT by 167% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Dong Feng Electronic TechnologyLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Dong Feng Electronic 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, Dong Feng Electronic TechnologyLtd actually produced more free cash flow than EBIT over the last three 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 it is always sensible to investigate a company's debt, in this case Dong Feng Electronic TechnologyLtd has CN¥2.80b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥148m, being 188% of its EBIT. The bottom line is that we do not find Dong Feng Electronic TechnologyLtd's debt levels at all concerning. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Dong Feng Electronic TechnologyLtd (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.