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

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. As with many other companies Shanghai Daimay Automotive Interior Co., Ltd (SHSE:603730) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shanghai Daimay Automotive Interior

What Is Shanghai Daimay Automotive Interior's Debt?

The image below, which you can click on for greater detail, shows that Shanghai Daimay Automotive Interior had debt of CN¥1.35b at the end of September 2024, a reduction from CN¥1.55b over a year. However, because it has a cash reserve of CN¥1.13b, its net debt is less, at about CN¥217.5m.

A Look At Shanghai Daimay Automotive Interior's Liabilities

The latest balance sheet data shows that Shanghai Daimay Automotive Interior had liabilities of CN¥1.31b due within a year, and liabilities of CN¥1.13b falling due after that. Offsetting these obligations, it had cash of CN¥1.13b as well as receivables valued at CN¥1.12b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥189.3m.

Having regard to Shanghai Daimay Automotive Interior's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥15.1b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, Shanghai Daimay Automotive Interior has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

Shanghai Daimay Automotive Interior's net debt is only 0.20 times its EBITDA. And its EBIT covers its interest expense a whopping 31.8 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Shanghai Daimay Automotive Interior has boosted its EBIT by 48%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Shanghai Daimay Automotive Interior recorded free cash flow of 23% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying 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 truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Zooming out, Shanghai Daimay Automotive Interior seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Given Shanghai Daimay Automotive Interior has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.