Is Henan Senyuan Electric (SZSE:002358) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Henan Senyuan Electric Co., Ltd. (SZSE:002358) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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, plenty of companies use debt to fund growth, without any negative consequences. 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 Henan Senyuan Electric

What Is Henan Senyuan Electric's Debt?

You can click the graphic below for the historical numbers, but it shows that Henan Senyuan Electric had CN¥2.03b of debt in September 2024, down from CN¥2.19b, one year before. And it doesn't have much cash, so its net debt is about the same.

A Look At Henan Senyuan Electric's Liabilities

Zooming in on the latest balance sheet data, we can see that Henan Senyuan Electric had liabilities of CN¥3.22b due within 12 months and liabilities of CN¥45.4m due beyond that. On the other hand, it had cash of CN¥34.3m and CN¥3.58b worth of receivables due within a year. So it can boast CN¥349.5m more liquid assets than total liabilities.

This surplus suggests that Henan Senyuan Electric has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Henan Senyuan Electric has net debt to EBITDA of 4.2 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 9.8 suggests it can easily service that debt. Importantly, Henan Senyuan Electric grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Henan Senyuan Electric 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last two years, Henan Senyuan Electric created free cash flow amounting to 13% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Henan Senyuan Electric's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its net debt to EBITDA. Looking at all the aforementioned factors together, it strikes us that Henan Senyuan Electric can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Henan Senyuan Electric you should be aware of.

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.