Here's Why Xi'an Sinofuse Electric (SZSE:301031) Has A Meaningful Debt Burden

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.' 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 Xi'an Sinofuse Electric Co., Ltd. (SZSE:301031) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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.

View our latest analysis for Xi'an Sinofuse Electric

What Is Xi'an Sinofuse Electric's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Xi'an Sinofuse Electric had CN¥191.6m of debt, an increase on CN¥60.5m, over one year. However, it does have CN¥141.1m in cash offsetting this, leading to net debt of about CN¥50.5m.

How Strong Is Xi'an Sinofuse Electric's Balance Sheet?

According to the last reported balance sheet, Xi'an Sinofuse Electric had liabilities of CN¥650.2m due within 12 months, and liabilities of CN¥8.07m due beyond 12 months. Offsetting this, it had CN¥141.1m in cash and CN¥767.5m in receivables that were due within 12 months. So it can boast CN¥250.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Xi'an Sinofuse Electric could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, Xi'an Sinofuse Electric has a very light debt load indeed.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Xi'an Sinofuse Electric's net debt is only 0.32 times its EBITDA. And its EBIT covers its interest expense a whopping 27.2 times over. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for Xi'an Sinofuse Electric if management cannot prevent a repeat of the 21% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Xi'an Sinofuse Electric can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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, Xi'an Sinofuse Electric saw substantial negative free cash flow, in total. 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

While Xi'an Sinofuse Electric's EBIT growth rate has us nervous. To wit both its interest cover and net debt to EBITDA were encouraging signs. We think that Xi'an Sinofuse Electric's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For example Xi'an Sinofuse Electric has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.