We Think Shenzhen Zhaowei Machinery & Electronics (SZSE:003021) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Shenzhen Zhaowei Machinery & Electronics Co., Ltd. (SZSE:003021) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shenzhen Zhaowei Machinery & Electronics

What Is Shenzhen Zhaowei Machinery & Electronics's Debt?

The chart below, which you can click on for greater detail, shows that Shenzhen Zhaowei Machinery & Electronics had CN¥40.2m in debt in September 2024; about the same as the year before. However, its balance sheet shows it holds CN¥1.07b in cash, so it actually has CN¥1.03b net cash.

How Healthy Is Shenzhen Zhaowei Machinery & Electronics' Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Zhaowei Machinery & Electronics had liabilities of CN¥713.8m falling due within a year, and liabilities of CN¥87.9m due beyond that. Offsetting these obligations, it had cash of CN¥1.07b as well as receivables valued at CN¥510.2m due within 12 months. So it can boast CN¥774.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Shenzhen Zhaowei Machinery & Electronics could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shenzhen Zhaowei Machinery & Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Shenzhen Zhaowei Machinery & Electronics has been able to increase its EBIT by 29% in twelve months, making it easier to pay down 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 Zhaowei Machinery & Electronics's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shenzhen Zhaowei Machinery & Electronics 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. Over the last three years, Shenzhen Zhaowei Machinery & Electronics recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Zhaowei Machinery & Electronics has net cash of CN¥1.03b, as well as more liquid assets than liabilities. And we liked the look of last year's 29% year-on-year EBIT growth. So we don't have any problem with Shenzhen Zhaowei Machinery & Electronics's use of debt. 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. Be aware that Shenzhen Zhaowei Machinery & Electronics is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.