Is Suzhou SLAC Precision EquipmentLtd (SZSE:300382) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Suzhou SLAC Precision Equipment CO.,Ltd. (SZSE:300382) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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.

See our latest analysis for Suzhou SLAC Precision EquipmentLtd

What Is Suzhou SLAC Precision EquipmentLtd's Net Debt?

As you can see below, at the end of September 2024, Suzhou SLAC Precision EquipmentLtd had CN¥1.71b of debt, up from CN¥1.32b a year ago. Click the image for more detail. On the flip side, it has CN¥552.1m in cash leading to net debt of about CN¥1.16b.

How Strong Is Suzhou SLAC Precision EquipmentLtd's Balance Sheet?

According to the last reported balance sheet, Suzhou SLAC Precision EquipmentLtd had liabilities of CN¥1.20b due within 12 months, and liabilities of CN¥1.34b due beyond 12 months. Offsetting this, it had CN¥552.1m in cash and CN¥776.7m in receivables that were due within 12 months. So its liabilities total CN¥1.21b more than the combination of its cash and short-term receivables.

Of course, Suzhou SLAC Precision EquipmentLtd has a market capitalization of CN¥8.40b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Weak interest cover of 0.053 times and a disturbingly high net debt to EBITDA ratio of 14.9 hit our confidence in Suzhou SLAC Precision EquipmentLtd like a one-two punch to the gut. The debt burden here is substantial. Even worse, Suzhou SLAC Precision EquipmentLtd saw its EBIT tank 98% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Suzhou SLAC Precision EquipmentLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Suzhou SLAC Precision EquipmentLtd 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

To be frank both Suzhou SLAC Precision EquipmentLtd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to handle its total liabilities isn't such a worry. Overall, it seems to us that Suzhou SLAC Precision EquipmentLtd's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Case in point: We've spotted 5 warning signs for Suzhou SLAC Precision EquipmentLtd you should be aware of, and 3 of them don't sit too well with us.

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.