Is Shijiazhuang Kelin Electric (SHSE:603050) A Risky Investment?

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 Shijiazhuang Kelin Electric Co., Ltd. (SHSE:603050) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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.

View our latest analysis for Shijiazhuang Kelin Electric

How Much Debt Does Shijiazhuang Kelin Electric Carry?

As you can see below, Shijiazhuang Kelin Electric had CN¥1.25b of debt at June 2024, down from CN¥1.49b a year prior. On the flip side, it has CN¥711.1m in cash leading to net debt of about CN¥542.4m.

A Look At Shijiazhuang Kelin Electric's Liabilities

We can see from the most recent balance sheet that Shijiazhuang Kelin Electric had liabilities of CN¥2.28b falling due within a year, and liabilities of CN¥1.27b due beyond that. Offsetting these obligations, it had cash of CN¥711.1m as well as receivables valued at CN¥2.37b due within 12 months. So its liabilities total CN¥467.6m more than the combination of its cash and short-term receivables.

Of course, Shijiazhuang Kelin Electric has a market capitalization of CN¥6.55b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Shijiazhuang Kelin Electric has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 11.0 times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Shijiazhuang Kelin Electric grew its EBIT by 119% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shijiazhuang Kelin Electric's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Shijiazhuang Kelin Electric burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Shijiazhuang Kelin Electric's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Shijiazhuang Kelin Electric can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Shijiazhuang Kelin Electric , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.