Is Jiujiang Defu Technology (SZSE:301511) A Risky Investment?

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 can see that Jiujiang Defu Technology Co., Limited (SZSE:301511) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

View our latest analysis for Jiujiang Defu Technology

What Is Jiujiang Defu Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Jiujiang Defu Technology had CN¥6.46b of debt, an increase on CN¥3.81b, over one year. However, it does have CN¥3.57b in cash offsetting this, leading to net debt of about CN¥2.89b.

How Healthy Is Jiujiang Defu Technology's Balance Sheet?

The latest balance sheet data shows that Jiujiang Defu Technology had liabilities of CN¥7.56b due within a year, and liabilities of CN¥1.58b falling due after that. Offsetting this, it had CN¥3.57b in cash and CN¥2.56b in receivables that were due within 12 months. So it has liabilities totalling CN¥3.01b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Jiujiang Defu Technology has a market capitalization of CN¥9.89b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

Weak interest cover of 0.89 times and a disturbingly high net debt to EBITDA ratio of 6.9 hit our confidence in Jiujiang Defu Technology like a one-two punch to the gut. The debt burden here is substantial. Even worse, Jiujiang Defu Technology saw its EBIT tank 80% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jiujiang Defu Technology'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Jiujiang Defu 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

On the face of it, Jiujiang Defu Technology'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. Having said that, its ability to handle its total liabilities isn't such a worry. After considering the datapoints discussed, we think Jiujiang Defu Technology has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Jiujiang Defu Technology (at least 3 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.

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.