Is Foshan Electrical and LightingLtd (SZSE:000541) Using Too Much 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.' 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 note that Foshan Electrical and Lighting Co.,Ltd (SZSE:000541) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Foshan Electrical and LightingLtd

What Is Foshan Electrical and LightingLtd's Net Debt?

As you can see below, at the end of September 2024, Foshan Electrical and LightingLtd had CN¥832.4m of debt, up from CN¥722.6m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥3.22b in cash, so it actually has CN¥2.38b net cash.

A Look At Foshan Electrical and LightingLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Foshan Electrical and LightingLtd had liabilities of CN¥6.76b due within 12 months and liabilities of CN¥561.6m due beyond that. On the other hand, it had cash of CN¥3.22b and CN¥3.72b worth of receivables due within a year. So it has liabilities totalling CN¥392.6m more than its cash and near-term receivables, combined.

Of course, Foshan Electrical and LightingLtd has a market capitalization of CN¥8.46b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Foshan Electrical and LightingLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Foshan Electrical and LightingLtd's load is not too heavy, because its EBIT was down 34% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Foshan Electrical and LightingLtd'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Foshan Electrical and LightingLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Foshan Electrical and LightingLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

We could understand if investors are concerned about Foshan Electrical and LightingLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥2.38b. The cherry on top was that in converted 138% of that EBIT to free cash flow, bringing in CN¥575m. So we are not troubled with Foshan Electrical and LightingLtd's debt use. 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. We've identified 2 warning signs with Foshan Electrical and LightingLtd , and understanding them should be part of your investment process.

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.

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.