We Think Sunwoda ElectronicLtd (SZSE:300207) Is Taking Some Risk With Its Debt

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. We can see that Sunwoda Electronic Co.,Ltd (SZSE:300207) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Sunwoda ElectronicLtd

What Is Sunwoda ElectronicLtd's Debt?

As you can see below, Sunwoda ElectronicLtd had CN¥17.8b of debt at March 2024, down from CN¥19.0b a year prior. However, it does have CN¥17.9b in cash offsetting this, leading to net cash of CN¥60.3m.

A Look At Sunwoda ElectronicLtd's Liabilities

We can see from the most recent balance sheet that Sunwoda ElectronicLtd had liabilities of CN¥32.9b falling due within a year, and liabilities of CN¥14.1b due beyond that. Offsetting this, it had CN¥17.9b in cash and CN¥13.1b in receivables that were due within 12 months. So it has liabilities totalling CN¥16.1b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Sunwoda ElectronicLtd has a market capitalization of CN¥28.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Sunwoda ElectronicLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Sunwoda ElectronicLtd grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Sunwoda ElectronicLtd'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Sunwoda ElectronicLtd 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. During the last three years, Sunwoda ElectronicLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

Although Sunwoda ElectronicLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥60.3m. And we liked the look of last year's 32% year-on-year EBIT growth. So while Sunwoda ElectronicLtd does not have a great balance sheet, it's certainly not too bad. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Sunwoda ElectronicLtd you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com