Sunward Intelligent Equipment (SZSE:002097) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Sunward Intelligent Equipment Co., Ltd. (SZSE:002097) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Sunward Intelligent Equipment

What Is Sunward Intelligent Equipment's Net Debt?

As you can see below, Sunward Intelligent Equipment had CN¥10.4b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥1.78b in cash, and so its net debt is CN¥8.58b.

How Strong Is Sunward Intelligent Equipment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sunward Intelligent Equipment had liabilities of CN¥9.28b due within 12 months and liabilities of CN¥7.19b due beyond that. On the other hand, it had cash of CN¥1.78b and CN¥7.67b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥7.03b.

This is a mountain of leverage relative to its market capitalization of CN¥7.43b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Weak interest cover of 0.23 times and a disturbingly high net debt to EBITDA ratio of 15.0 hit our confidence in Sunward Intelligent Equipment like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Sunward Intelligent Equipment is that it turned last year's EBIT loss into a gain of CN¥75m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sunward Intelligent Equipment's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Sunward Intelligent Equipment saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Sunward Intelligent Equipment's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. We're quite clear that we consider Sunward Intelligent Equipment to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Sunward Intelligent Equipment (of which 4 are concerning!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.