We Think Sieyuan Electric (SZSE:002028) Can Manage Its Debt With Ease

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Sieyuan Electric Co., Ltd. (SZSE:002028) does carry debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sieyuan Electric

What Is Sieyuan Electric's Debt?

As you can see below, at the end of June 2024, Sieyuan Electric had CN¥163.2m of debt, up from CN¥55.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥4.61b in cash, so it actually has CN¥4.45b net cash.

How Strong Is Sieyuan Electric's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sieyuan Electric had liabilities of CN¥8.19b due within 12 months and liabilities of CN¥192.3m due beyond that. Offsetting this, it had CN¥4.61b in cash and CN¥6.85b in receivables that were due within 12 months. So it can boast CN¥3.08b more liquid assets than total liabilities.

This short term liquidity is a sign that Sieyuan Electric could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Sieyuan Electric has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Sieyuan Electric has been able to increase its EBIT by 29% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sieyuan Electric can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Sieyuan Electric 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 most recent three years, Sieyuan Electric recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sieyuan Electric has net cash of CN¥4.45b, as well as more liquid assets than liabilities. And we liked the look of last year's 29% year-on-year EBIT growth. So we don't think Sieyuan Electric's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Sieyuan Electric's earnings per share history for free.

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.