Qingdao Sentury Tire (SZSE:002984) Seems To Use Debt Quite Sensibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Qingdao Sentury Tire Co., Ltd. (SZSE:002984) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Qingdao Sentury Tire

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. However, it does have CN¥3.33b in cash offsetting this, leading to net cash of CN¥1.22b.

How Strong 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.

On top of that, Qingdao Sentury Tire grew its EBIT by 98% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Qingdao Sentury Tire's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. 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. For us, cash conversion that low sparks a little paranoia about is ability to extinguish 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 it impressed us with its EBIT growth of 98% over the last year. 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. To that end, you should learn about the 2 warning signs we've spotted with Qingdao Sentury Tire (including 1 which can't be ignored) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.