Jiangsu Tongguang Electronic Wire & Cable (SZSE:300265) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Jiangsu Tongguang Electronic Wire & Cable Co., Ltd. (SZSE:300265) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Jiangsu Tongguang Electronic Wire & Cable

What Is Jiangsu Tongguang Electronic Wire & Cable's Debt?

As you can see below, Jiangsu Tongguang Electronic Wire & Cable had CN¥410.0m of debt at March 2024, down from CN¥824.7m a year prior. However, because it has a cash reserve of CN¥402.2m, its net debt is less, at about CN¥7.76m.

A Look At Jiangsu Tongguang Electronic Wire & Cable's Liabilities

According to the last reported balance sheet, Jiangsu Tongguang Electronic Wire & Cable had liabilities of CN¥923.6m due within 12 months, and liabilities of CN¥139.8m due beyond 12 months. On the other hand, it had cash of CN¥402.2m and CN¥1.38b worth of receivables due within a year. So it actually has CN¥721.9m more liquid assets than total liabilities.

It's good to see that Jiangsu Tongguang Electronic Wire & Cable has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. But either way, Jiangsu Tongguang Electronic Wire & Cable has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Jiangsu Tongguang Electronic Wire & Cable has very modest net debt, giving rise to a debt to EBITDA ratio of 0.055. And EBIT easily covered the interest expense 7.7 times over, lending force to that view. On the other hand, Jiangsu Tongguang Electronic Wire & Cable's EBIT dived 19%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Jiangsu Tongguang Electronic Wire & Cable will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. Over the last three years, Jiangsu Tongguang Electronic Wire & Cable saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

While Jiangsu Tongguang Electronic Wire & Cable's EBIT growth rate makes us cautious about it, its track record of converting EBIT to free cash flow is no better. But at least its net debt to EBITDA is a gleaming silver lining to those clouds. We think that Jiangsu Tongguang Electronic Wire & Cable's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. We've identified 3 warning signs with Jiangsu Tongguang Electronic Wire & Cable , and understanding them should be part of your investment process.

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.

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

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.