Is Beijing Chieftain Control Engineering Technology (SZSE:300430) 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.' 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 note that Beijing Chieftain Control Engineering Technology Co., Ltd. (SZSE:300430) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Beijing Chieftain Control Engineering Technology

What Is Beijing Chieftain Control Engineering Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Beijing Chieftain Control Engineering Technology had CN¥630.0m of debt, an increase on CN¥516.7m, over one year. On the flip side, it has CN¥178.0m in cash leading to net debt of about CN¥452.0m.

How Strong Is Beijing Chieftain Control Engineering Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Beijing Chieftain Control Engineering Technology had liabilities of CN¥1.05b due within 12 months and liabilities of CN¥204.2m due beyond that. Offsetting these obligations, it had cash of CN¥178.0m as well as receivables valued at CN¥1.03b due within 12 months. So its liabilities total CN¥44.5m more than the combination of its cash and short-term receivables.

Having regard to Beijing Chieftain Control Engineering Technology's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥4.41b company is struggling for cash, we still think it's worth monitoring its balance sheet.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Beijing Chieftain Control Engineering Technology's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its strong interest cover of 10.5 times, makes us even more comfortable. Importantly, Beijing Chieftain Control Engineering Technology grew its EBIT by 34% 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 Beijing Chieftain Control Engineering Technology'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Beijing Chieftain Control Engineering Technology 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

The good news is that Beijing Chieftain Control Engineering Technology's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Beijing Chieftain Control Engineering Technology can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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 1 warning sign with Beijing Chieftain Control Engineering Technology , 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.