Is FangDa Carbon New MaterialLtd (SHSE:600516) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, FangDa Carbon New Material Co.,Ltd (SHSE:600516) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for FangDa Carbon New MaterialLtd

What Is FangDa Carbon New MaterialLtd's Net Debt?

As you can see below, at the end of March 2024, FangDa Carbon New MaterialLtd had CN¥1.41b of debt, up from CN¥1.08b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥7.11b in cash, so it actually has CN¥5.70b net cash.

A Look At FangDa Carbon New MaterialLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that FangDa Carbon New MaterialLtd had liabilities of CN¥2.35b due within 12 months and liabilities of CN¥1.07b due beyond that. Offsetting this, it had CN¥7.11b in cash and CN¥2.11b in receivables that were due within 12 months. So it actually has CN¥5.80b more liquid assets than total liabilities.

This surplus suggests that FangDa Carbon New MaterialLtd is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that FangDa Carbon New MaterialLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that FangDa Carbon New MaterialLtd's load is not too heavy, because its EBIT was down 29% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 FangDa Carbon New MaterialLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. FangDa Carbon New MaterialLtd 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. Looking at the most recent three years, FangDa Carbon New MaterialLtd recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that FangDa Carbon New MaterialLtd has net cash of CN¥5.70b, as well as more liquid assets than liabilities. So we don't have any problem with FangDa Carbon New MaterialLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with FangDa Carbon New MaterialLtd .

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.