Is Xinya Electronic (SHSE:605277) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 can see that Xinya Electronic Co., Ltd. (SHSE:605277) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Xinya Electronic

What Is Xinya Electronic's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Xinya Electronic had CN¥952.0m of debt, an increase on CN¥756.1m, over one year. However, it also had CN¥307.1m in cash, and so its net debt is CN¥644.9m.

A Look At Xinya Electronic's Liabilities

We can see from the most recent balance sheet that Xinya Electronic had liabilities of CN¥1.38b falling due within a year, and liabilities of CN¥440.1m due beyond that. Offsetting these obligations, it had cash of CN¥307.1m as well as receivables valued at CN¥1.01b due within 12 months. So its liabilities total CN¥502.4m more than the combination of its cash and short-term receivables.

Given Xinya Electronic has a market capitalization of CN¥5.65b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a debt to EBITDA ratio of 2.4, Xinya Electronic uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 9.8 times its interest expenses harmonizes with that theme. Unfortunately, Xinya Electronic saw its EBIT slide 9.2% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Xinya Electronic will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Xinya Electronic produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On our analysis Xinya Electronic's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to grow its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about Xinya Electronic's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. For example Xinya Electronic has 3 warning signs (and 1 which is concerning) we think you should know about.

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.