Is Jiusheng Electric (SZSE:301082) Using Too Much Debt?

Warren Buffett famously said, '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 Jiusheng Electric Co., Ltd. (SZSE:301082) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Jiusheng Electric's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Jiusheng Electric had debt of CN¥1.24b, up from CN¥738.3m in one year. On the flip side, it has CN¥335.4m in cash leading to net debt of about CN¥908.1m.

How Healthy Is Jiusheng Electric's Balance Sheet?

We can see from the most recent balance sheet that Jiusheng Electric had liabilities of CN¥2.05b falling due within a year, and liabilities of CN¥190.9m due beyond that. On the other hand, it had cash of CN¥335.4m and CN¥2.35b worth of receivables due within a year. So it actually has CN¥449.1m more liquid assets than total liabilities.

This surplus suggests that Jiusheng Electric has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

Check out our latest analysis for Jiusheng Electric

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.

Jiusheng Electric shareholders face the double whammy of a high net debt to EBITDA ratio (13.3), and fairly weak interest coverage, since EBIT is just 1.3 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, Jiusheng Electric's EBIT was down 55% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jiusheng Electric'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.

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. During the last three years, Jiusheng Electric 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

On the face of it, Jiusheng Electric's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its level of total liabilities is a good sign, and makes us more optimistic. Overall, it seems to us that Jiusheng Electric'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. 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. Be aware that Jiusheng Electric is showing 6 warning signs in our investment analysis , and 5 of those are concerning...

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.