We Think Shenzhen Desay Battery Technology (SZSE:000049) Is Taking Some Risk With Its Debt

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. As with many other companies Shenzhen Desay Battery Technology Co., Ltd. (SZSE:000049) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shenzhen Desay Battery Technology

How Much Debt Does Shenzhen Desay Battery Technology Carry?

The chart below, which you can click on for greater detail, shows that Shenzhen Desay Battery Technology had CN¥3.94b in debt in September 2024; about the same as the year before. On the flip side, it has CN¥2.38b in cash leading to net debt of about CN¥1.56b.

A Look At Shenzhen Desay Battery Technology's Liabilities

According to the last reported balance sheet, Shenzhen Desay Battery Technology had liabilities of CN¥7.69b due within 12 months, and liabilities of CN¥2.82b due beyond 12 months. On the other hand, it had cash of CN¥2.38b and CN¥5.85b worth of receivables due within a year. So it has liabilities totalling CN¥2.28b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Shenzhen Desay Battery Technology is worth CN¥9.44b, 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.

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).

Shenzhen Desay Battery Technology's net debt is only 1.4 times its EBITDA. And its EBIT covers its interest expense a whopping 11.1 times over. So we're pretty relaxed about its super-conservative use of debt. But the bad news is that Shenzhen Desay Battery Technology has seen its EBIT plunge 11% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shenzhen Desay Battery Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Shenzhen Desay Battery Technology saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Shenzhen Desay Battery Technology's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its interest cover was refreshing. Taking the abovementioned factors together we do think Shenzhen Desay Battery Technology's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Shenzhen Desay Battery Technology 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.