Is Shenzhen Envicool Technology (SZSE:002837) 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. Importantly, Shenzhen Envicool Technology Co., Ltd. (SZSE:002837) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Shenzhen Envicool Technology

How Much Debt Does Shenzhen Envicool Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shenzhen Envicool Technology had CN¥694.0m of debt, an increase on CN¥518.4m, over one year. But it also has CN¥887.4m in cash to offset that, meaning it has CN¥193.5m net cash.

A Look At Shenzhen Envicool Technology's Liabilities

According to the last reported balance sheet, Shenzhen Envicool Technology had liabilities of CN¥2.50b due within 12 months, and liabilities of CN¥307.3m due beyond 12 months. On the other hand, it had cash of CN¥887.4m and CN¥2.45b worth of receivables due within a year. So it can boast CN¥533.3m more liquid assets than total liabilities.

Having regard to Shenzhen Envicool Technology's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥33.2b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Shenzhen Envicool Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Shenzhen Envicool Technology grew its EBIT by 44% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shenzhen Envicool Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shenzhen Envicool Technology 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 three years, Shenzhen Envicool Technology's free cash flow amounted to 31% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen Envicool Technology has CN¥193.5m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 44% over the last year. So is Shenzhen Envicool Technology's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Shenzhen Envicool Technology that you should be aware of before investing here.

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.