These 4 Measures Indicate That Tongling Jingda Special Magnet Wire (SHSE:600577) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Tongling Jingda Special Magnet Wire Co., Ltd. (SHSE:600577) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Tongling Jingda Special Magnet Wire

How Much Debt Does Tongling Jingda Special Magnet Wire Carry?

The chart below, which you can click on for greater detail, shows that Tongling Jingda Special Magnet Wire had CN¥3.34b in debt in December 2023; about the same as the year before. However, it does have CN¥1.90b in cash offsetting this, leading to net debt of about CN¥1.44b.

A Look At Tongling Jingda Special Magnet Wire's Liabilities

According to the last reported balance sheet, Tongling Jingda Special Magnet Wire had liabilities of CN¥5.17b due within 12 months, and liabilities of CN¥760.6m due beyond 12 months. Offsetting this, it had CN¥1.90b in cash and CN¥4.82b in receivables that were due within 12 months. So it actually has CN¥790.7m more liquid assets than total liabilities.

This surplus suggests that Tongling Jingda Special Magnet Wire has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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 net debt worth 1.8 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.5 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Tongling Jingda Special Magnet Wire grew its EBIT by 3.5% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Tongling Jingda Special Magnet Wire's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Tongling Jingda Special Magnet Wire created free cash flow amounting to 2.8% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Tongling Jingda Special Magnet Wire's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that it has an adequate capacity to handle its total liabilities. When we consider all the factors mentioned above, we do feel a bit cautious about Tongling Jingda Special Magnet Wire's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 1 warning sign for Tongling Jingda Special Magnet Wire you should be aware of.

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.