These 4 Measures Indicate That Sumec (SHSE:600710) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Sumec Corporation Limited (SHSE:600710) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Sumec

What Is Sumec's Debt?

The image below, which you can click on for greater detail, shows that Sumec had debt of CN¥3.01b at the end of September 2024, a reduction from CN¥3.90b over a year. But on the other hand it also has CN¥13.5b in cash, leading to a CN¥10.5b net cash position.

A Look At Sumec's Liabilities

We can see from the most recent balance sheet that Sumec had liabilities of CN¥39.8b falling due within a year, and liabilities of CN¥3.11b due beyond that. Offsetting these obligations, it had cash of CN¥13.5b as well as receivables valued at CN¥14.8b due within 12 months. So it has liabilities totalling CN¥14.6b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥11.9b, we think shareholders really should watch Sumec's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Sumec boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Also good is that Sumec grew its EBIT at 17% over the last year, further increasing its ability to manage 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 Sumec'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Sumec has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Sumec actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Sumec's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥10.5b. The cherry on top was that in converted 131% of that EBIT to free cash flow, bringing in CN¥6.1b. So we are not troubled with Sumec's debt use. 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. We've identified 1 warning sign with Sumec , and understanding them should be part of your investment process.

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.