Is Sanbian Sci Tech (SZSE:002112) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Sanbian Sci Tech Co., Ltd. (SZSE:002112) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

Check out our latest analysis for Sanbian Sci Tech

How Much Debt Does Sanbian Sci Tech Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Sanbian Sci Tech had debt of CN¥897.1m, up from CN¥783.6m in one year. On the flip side, it has CN¥185.1m in cash leading to net debt of about CN¥711.9m.

A Look At Sanbian Sci Tech's Liabilities

We can see from the most recent balance sheet that Sanbian Sci Tech had liabilities of CN¥1.37b falling due within a year, and liabilities of CN¥173.2m due beyond that. Offsetting these obligations, it had cash of CN¥185.1m as well as receivables valued at CN¥861.3m due within 12 months. So its liabilities total CN¥500.5m more than the combination of its cash and short-term receivables.

Of course, Sanbian Sci Tech has a market capitalization of CN¥4.58b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sanbian Sci Tech has a debt to EBITDA ratio of 3.8 and its EBIT covered its interest expense 5.4 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably, Sanbian Sci Tech's EBIT launched higher than Elon Musk, gaining a whopping 102% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sanbian Sci Tech will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Sanbian Sci Tech 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

Sanbian Sci Tech's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. When we consider all the factors mentioned above, we do feel a bit cautious about Sanbian Sci Tech's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. To that end, you should learn about the 3 warning signs we've spotted with Sanbian Sci Tech (including 2 which are a bit unpleasant) .

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.