Is Shenzhen SED Industry (SZSE:000032) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Shenzhen SED Industry Co., Ltd. (SZSE:000032) does use debt in its business. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Shenzhen SED Industry

How Much Debt Does Shenzhen SED Industry Carry?

As you can see below, Shenzhen SED Industry had CN¥9.91b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥10.8b in cash to offset that, meaning it has CN¥883.8m net cash.

How Healthy Is Shenzhen SED Industry's Balance Sheet?

The latest balance sheet data shows that Shenzhen SED Industry had liabilities of CN¥40.3b due within a year, and liabilities of CN¥7.76b falling due after that. Offsetting this, it had CN¥10.8b in cash and CN¥31.4b in receivables that were due within 12 months. So its liabilities total CN¥5.90b more than the combination of its cash and short-term receivables.

Shenzhen SED Industry has a market capitalization of CN¥21.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Shenzhen SED Industry also has more cash than debt, so we're pretty confident it can manage its debt safely.

Unfortunately, Shenzhen SED Industry saw its EBIT slide 8.8% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shenzhen SED Industry 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, a company can only pay off debt with cold hard cash, not accounting profits. While Shenzhen SED Industry 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. Over the last three years, Shenzhen SED Industry reported free cash flow worth 19% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

Although Shenzhen SED Industry'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¥883.8m. So although we see some areas for improvement, we're not too worried about Shenzhen SED Industry's balance sheet. 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 3 warning signs with Shenzhen SED Industry (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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

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.