These 4 Measures Indicate That Shanghai Taisheng Wind Power Equipment (SZSE:300129) Is Using Debt Reasonably Well

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. We can see that Shanghai Taisheng Wind Power Equipment Co., Ltd. (SZSE:300129) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shanghai Taisheng Wind Power Equipment

What Is Shanghai Taisheng Wind Power Equipment's Debt?

As you can see below, at the end of September 2024, Shanghai Taisheng Wind Power Equipment had CN¥1.18b of debt, up from CN¥332.5m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥873.8m, its net debt is less, at about CN¥305.6m.

How Healthy Is Shanghai Taisheng Wind Power Equipment's Balance Sheet?

The latest balance sheet data shows that Shanghai Taisheng Wind Power Equipment had liabilities of CN¥3.93b due within a year, and liabilities of CN¥554.1m falling due after that. Offsetting these obligations, it had cash of CN¥873.8m as well as receivables valued at CN¥3.54b due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Shanghai Taisheng Wind Power Equipment's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥6.68b company is short on cash, but still worth keeping an eye on the balance sheet.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shanghai Taisheng Wind Power Equipment's net debt is only 0.83 times its EBITDA. And its EBIT easily covers its interest expense, being 15.3 times the size. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Shanghai Taisheng Wind Power Equipment saw its EBIT decline by 7.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Taisheng Wind Power Equipment'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. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Shanghai Taisheng Wind Power Equipment burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen Shanghai Taisheng Wind Power Equipment is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Shanghai Taisheng Wind Power Equipment'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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Shanghai Taisheng Wind Power Equipment (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.