Here's Why Tongling Jingda Special Magnet Wire (SHSE:600577) Can Manage Its Debt Responsibly

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.' 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 Tongling Jingda Special Magnet Wire Co., Ltd. (SHSE:600577) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Tongling Jingda Special Magnet Wire

How Much Debt Does Tongling Jingda Special Magnet Wire Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Tongling Jingda Special Magnet Wire had debt of CN¥3.78b, up from CN¥3.55b in one year. However, it does have CN¥1.75b in cash offsetting this, leading to net debt of about CN¥2.03b.

A Look At Tongling Jingda Special Magnet Wire's Liabilities

The latest balance sheet data shows that Tongling Jingda Special Magnet Wire had liabilities of CN¥5.39b due within a year, and liabilities of CN¥701.9m falling due after that. Offsetting this, it had CN¥1.75b in cash and CN¥5.17b in receivables that were due within 12 months. So it actually has CN¥830.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Tongling Jingda Special Magnet Wire could probably pay off its debt with ease, as its balance sheet is far from stretched.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Tongling Jingda Special Magnet Wire has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 5.4 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Tongling Jingda Special Magnet Wire grew its EBIT by 6.0% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. 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 Tongling Jingda Special Magnet Wire 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, Tongling Jingda Special Magnet Wire actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Based on what we've seen Tongling Jingda Special Magnet Wire is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we thought its level of total liabilities was a positive. Looking at all this data makes us feel a little cautious about Tongling Jingda Special Magnet Wire's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more 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, we've discovered 1 warning sign for Tongling Jingda Special Magnet Wire that you should be aware of before investing here.

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.