Is Shenzhen Center Power Tech (SZSE:002733) A Risky Investment?

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.' 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 Shenzhen Center Power Tech. Co., Ltd (SZSE:002733) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shenzhen Center Power Tech

What Is Shenzhen Center Power Tech's Net Debt?

As you can see below, at the end of March 2024, Shenzhen Center Power Tech had CN¥921.4m of debt, up from CN¥768.6m a year ago. Click the image for more detail. However, it does have CN¥1.26b in cash offsetting this, leading to net cash of CN¥334.3m.

A Look At Shenzhen Center Power Tech's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen Center Power Tech had liabilities of CN¥1.75b due within 12 months and liabilities of CN¥421.6m due beyond that. On the other hand, it had cash of CN¥1.26b and CN¥1.14b worth of receivables due within a year. So it can boast CN¥218.6m more liquid assets than total liabilities.

This surplus suggests that Shenzhen Center Power Tech has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shenzhen Center Power Tech has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Shenzhen Center Power Tech has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shenzhen Center Power Tech'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Shenzhen Center Power Tech may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last two years, Shenzhen Center Power Tech created free cash flow amounting to 4.7% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen Center Power Tech has CN¥334.3m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 22% over the last year. So we are not troubled with Shenzhen Center Power Tech's debt use. 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 3 warning signs for Shenzhen Center Power Tech you should be aware of, and 1 of them is significant.

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.