Would Zhejiang Tony Electronic (SHSE:603595) Be Better Off With Less Debt?

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.' 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. Importantly, Zhejiang Tony Electronic Co., Ltd (SHSE:603595) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Zhejiang Tony Electronic

What Is Zhejiang Tony Electronic's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Zhejiang Tony Electronic had debt of CN¥1.91b, up from CN¥1.72b in one year. However, it also had CN¥95.6m in cash, and so its net debt is CN¥1.82b.

How Healthy Is Zhejiang Tony Electronic's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Tony Electronic had liabilities of CN¥2.45b falling due within a year, and liabilities of CN¥878.5m due beyond that. On the other hand, it had cash of CN¥95.6m and CN¥783.3m worth of receivables due within a year. So its liabilities total CN¥2.45b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Zhejiang Tony Electronic is worth CN¥5.15b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zhejiang Tony Electronic'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.

Over 12 months, Zhejiang Tony Electronic reported revenue of CN¥1.9b, which is a gain of 4.0%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Zhejiang Tony Electronic had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable CN¥613m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥970m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Zhejiang Tony Electronic that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com