Is SUFA Technology Industry CNNC (SZSE:000777) 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.' 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 SUFA Technology Industry Co., Ltd., CNNC (SZSE:000777) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SUFA Technology Industry CNNC

What Is SUFA Technology Industry CNNC's Debt?

You can click the graphic below for the historical numbers, but it shows that SUFA Technology Industry CNNC had CN¥177.6m of debt in September 2023, down from CN¥249.9m, one year before. However, it also had CN¥92.5m in cash, and so its net debt is CN¥85.1m.

A Look At SUFA Technology Industry CNNC's Liabilities

Zooming in on the latest balance sheet data, we can see that SUFA Technology Industry CNNC had liabilities of CN¥1.22b due within 12 months and liabilities of CN¥67.2m due beyond that. On the other hand, it had cash of CN¥92.5m and CN¥1.19b worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to SUFA Technology Industry CNNC's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥5.36b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

SUFA Technology Industry CNNC has a low debt to EBITDA ratio of only 0.82. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. It was also good to see that despite losing money on the EBIT line last year, SUFA Technology Industry CNNC turned things around in the last 12 months, delivering and EBIT of CN¥77m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine SUFA Technology Industry CNNC'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, SUFA Technology Industry CNNC burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen SUFA Technology Industry CNNC is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about SUFA Technology Industry CNNC'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. 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. To that end, you should be aware of the 1 warning sign we've spotted with SUFA Technology Industry CNNC .

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.

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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.