Is Ningbo KBE Electrical TechnologyLtd (SZSE:300863) A Risky Investment?

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 Ningbo KBE Electrical Technology Co.,Ltd. (SZSE:300863) does use debt in its business. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Ningbo KBE Electrical TechnologyLtd

What Is Ningbo KBE Electrical TechnologyLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Ningbo KBE Electrical TechnologyLtd had debt of CN¥1.83b, up from CN¥1.35b in one year. However, it also had CN¥386.9m in cash, and so its net debt is CN¥1.45b.

How Healthy Is Ningbo KBE Electrical TechnologyLtd's Balance Sheet?

The latest balance sheet data shows that Ningbo KBE Electrical TechnologyLtd had liabilities of CN¥1.61b due within a year, and liabilities of CN¥531.2m falling due after that. Offsetting these obligations, it had cash of CN¥386.9m as well as receivables valued at CN¥1.33b due within 12 months. So it has liabilities totalling CN¥425.5m more than its cash and near-term receivables, combined.

Of course, Ningbo KBE Electrical TechnologyLtd has a market capitalization of CN¥6.06b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Ningbo KBE Electrical TechnologyLtd's debt is 4.5 times its EBITDA, and its EBIT cover its interest expense 4.7 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. If Ningbo KBE Electrical TechnologyLtd can keep growing EBIT at last year's rate of 11% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Ningbo KBE Electrical TechnologyLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ningbo KBE Electrical TechnologyLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Ningbo KBE Electrical TechnologyLtd's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its EBIT growth rate is relatively strong. Looking at all the angles mentioned above, it does seem to us that Ningbo KBE Electrical TechnologyLtd is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Case in point: We've spotted 2 warning signs for Ningbo KBE Electrical TechnologyLtd you should be aware of, and 1 of them shouldn't be ignored.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.