Here's Why Shanghai Daimay Automotive Interior (SHSE:603730) Can Manage Its Debt Responsibly

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 Shanghai Daimay Automotive Interior Co., Ltd (SHSE:603730) 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Shanghai Daimay Automotive Interior

How Much Debt Does Shanghai Daimay Automotive Interior Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shanghai Daimay Automotive Interior had CN¥1.13b of debt, an increase on CN¥450.0m, over one year. On the flip side, it has CN¥1.10b in cash leading to net debt of about CN¥34.2m.

How Strong Is Shanghai Daimay Automotive Interior's Balance Sheet?

According to the last reported balance sheet, Shanghai Daimay Automotive Interior had liabilities of CN¥1.02b due within 12 months, and liabilities of CN¥1.09b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.10b as well as receivables valued at CN¥1.11b due within 12 months. So it actually has CN¥95.9m more liquid assets than total liabilities.

Having regard to Shanghai Daimay Automotive Interior's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥14.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Shanghai Daimay Automotive Interior has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With debt at a measly 0.033 times EBITDA and EBIT covering interest a whopping 26.0 times, it's clear that Shanghai Daimay Automotive Interior is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. In addition to that, we're happy to report that Shanghai Daimay Automotive Interior has boosted its EBIT by 75%, thus reducing the spectre of future debt repayments. 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 Shanghai Daimay Automotive Interior'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Shanghai Daimay Automotive Interior created free cash flow amounting to 13% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Shanghai Daimay Automotive Interior's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Zooming out, Shanghai Daimay Automotive Interior seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. For instance, we've identified 1 warning sign for Shanghai Daimay Automotive Interior that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.