Is Suzhou Secote Precision ElectronicLTD (SHSE:603283) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Suzhou Secote Precision Electronic Co.,LTD (SHSE:603283) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Suzhou Secote Precision ElectronicLTD

How Much Debt Does Suzhou Secote Precision ElectronicLTD Carry?

As you can see below, at the end of September 2024, Suzhou Secote Precision ElectronicLTD had CN¥1.00b of debt, up from CN¥764.3m a year ago. Click the image for more detail. On the flip side, it has CN¥734.0m in cash leading to net debt of about CN¥270.4m.

How Strong Is Suzhou Secote Precision ElectronicLTD's Balance Sheet?

We can see from the most recent balance sheet that Suzhou Secote Precision ElectronicLTD had liabilities of CN¥3.11b falling due within a year, and liabilities of CN¥100.0m due beyond that. Offsetting these obligations, it had cash of CN¥734.0m as well as receivables valued at CN¥2.18b due within 12 months. So it has liabilities totalling CN¥299.6m more than its cash and near-term receivables, combined.

Given Suzhou Secote Precision ElectronicLTD has a market capitalization of CN¥14.4b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Suzhou Secote Precision ElectronicLTD's net debt is only 0.26 times its EBITDA. And its EBIT easily covers its interest expense, being 239 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Suzhou Secote Precision ElectronicLTD has boosted its EBIT by 80%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Suzhou Secote Precision ElectronicLTD 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Suzhou Secote Precision ElectronicLTD's free cash flow amounted to 32% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Suzhou Secote Precision ElectronicLTD's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Looking at the bigger picture, we think Suzhou Secote Precision ElectronicLTD's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Suzhou Secote Precision ElectronicLTD has 1 warning sign we think you should be aware of.

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.