Here's Why Beijing Aerospace Shenzhou Intelligent Equipment Technology (SZSE:300455) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Beijing Aerospace Shenzhou Intelligent Equipment Technology Co., Ltd. (SZSE:300455) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Beijing Aerospace Shenzhou Intelligent Equipment Technology

What Is Beijing Aerospace Shenzhou Intelligent Equipment Technology's Net Debt?

The image below, which you can click on for greater detail, shows that Beijing Aerospace Shenzhou Intelligent Equipment Technology had debt of CN¥360.0m at the end of June 2024, a reduction from CN¥381.0m over a year. However, it does have CN¥190.3m in cash offsetting this, leading to net debt of about CN¥169.7m.

How Healthy Is Beijing Aerospace Shenzhou Intelligent Equipment Technology's Balance Sheet?

The latest balance sheet data shows that Beijing Aerospace Shenzhou Intelligent Equipment Technology had liabilities of CN¥1.30b due within a year, and liabilities of CN¥82.6m falling due after that. Offsetting this, it had CN¥190.3m in cash and CN¥708.7m in receivables that were due within 12 months. So its liabilities total CN¥488.1m more than the combination of its cash and short-term receivables.

Given Beijing Aerospace Shenzhou Intelligent Equipment Technology has a market capitalization of CN¥7.32b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Beijing Aerospace Shenzhou Intelligent Equipment Technology has net debt of just 1.4 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 9.6 times the interest expense over the last year. Also good is that Beijing Aerospace Shenzhou Intelligent Equipment Technology grew its EBIT at 12% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Beijing Aerospace Shenzhou Intelligent Equipment Technology will need earnings to service that debt. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Beijing Aerospace Shenzhou Intelligent Equipment Technology 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

Beijing Aerospace Shenzhou Intelligent Equipment Technology's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Beijing Aerospace Shenzhou Intelligent Equipment Technology'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 Beijing Aerospace Shenzhou Intelligent Equipment Technology (at least 2 which are significant) , 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.