Qingdao Sentury Tire (SZSE:002984) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Qingdao Sentury Tire Co., Ltd. (SZSE:002984) does use debt in its business. But the more important question is: how much risk is that debt creating?

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When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Qingdao Sentury Tire's Debt?

As you can see below, at the end of September 2024, Qingdao Sentury Tire had CN¥2.11b of debt, up from CN¥1.97b a year ago. Click the image for more detail. But on the other hand it also has CN¥3.33b in cash, leading to a CN¥1.22b net cash position.

How Healthy Is Qingdao Sentury Tire's Balance Sheet?

According to the last reported balance sheet, Qingdao Sentury Tire had liabilities of CN¥1.84b due within 12 months, and liabilities of CN¥2.14b due beyond 12 months. On the other hand, it had cash of CN¥3.33b and CN¥1.26b worth of receivables due within a year. So it actually has CN¥608.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Qingdao Sentury Tire could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Qingdao Sentury Tire has more cash than debt is arguably a good indication that it can manage its debt safely.

See our latest analysis for Qingdao Sentury Tire

In addition to that, we're happy to report that Qingdao Sentury Tire has boosted its EBIT by 98%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Qingdao Sentury Tire can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Qingdao Sentury Tire 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, Qingdao Sentury Tire created free cash flow amounting to 16% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Qingdao Sentury Tire has net cash of CN¥1.22b, as well as more liquid assets than liabilities. And we liked the look of last year's 98% year-on-year EBIT growth. So we don't think Qingdao Sentury Tire's use of debt is risky. 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. For example Qingdao Sentury Tire has 2 warning signs (and 1 which is concerning) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.