Here's Why Chengdu Xiling Power Science & Technology (SZSE:300733) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Chengdu Xiling Power Science & Technology Incorporated Company (SZSE:300733) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Chengdu Xiling Power Science & Technology

What Is Chengdu Xiling Power Science & Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Chengdu Xiling Power Science & Technology had CN¥422.0m of debt in September 2024, down from CN¥555.6m, one year before. However, it does have CN¥193.5m in cash offsetting this, leading to net debt of about CN¥228.5m.

A Look At Chengdu Xiling Power Science & Technology's Liabilities

According to the last reported balance sheet, Chengdu Xiling Power Science & Technology had liabilities of CN¥1.32b due within 12 months, and liabilities of CN¥82.3m due beyond 12 months. On the other hand, it had cash of CN¥193.5m and CN¥809.8m worth of receivables due within a year. So its liabilities total CN¥400.4m more than the combination of its cash and short-term receivables.

Since publicly traded Chengdu Xiling Power Science & Technology shares are worth a total of CN¥4.56b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Chengdu Xiling Power Science & Technology has a very low debt to EBITDA ratio of 1.4 so it is strange to see weak interest coverage, with last year's EBIT being only 1.3 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. It is well worth noting that Chengdu Xiling Power Science & Technology's EBIT shot up like bamboo after rain, gaining 70% in the last twelve months. That'll make it easier to manage 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 Chengdu Xiling Power Science & Technology'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Chengdu Xiling Power Science & Technology saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We weren't impressed with Chengdu Xiling Power Science & Technology's interest cover, and its conversion of EBIT to free cash flow made us cautious. But its EBIT growth rate was significantly redeeming. Looking at all this data makes us feel a little cautious about Chengdu Xiling Power Science & Technology's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. While Chengdu Xiling Power Science & Technology didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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.