Is Sinoma Energy Conservation (SHSE:603126) 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 Sinoma Energy Conservation Ltd. (SHSE:603126) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sinoma Energy Conservation

What Is Sinoma Energy Conservation's Debt?

As you can see below, at the end of September 2024, Sinoma Energy Conservation had CN¥445.7m of debt, up from CN¥403.2m a year ago. Click the image for more detail. But it also has CN¥714.7m in cash to offset that, meaning it has CN¥269.0m net cash.

How Strong Is Sinoma Energy Conservation's Balance Sheet?

According to the last reported balance sheet, Sinoma Energy Conservation had liabilities of CN¥2.28b due within 12 months, and liabilities of CN¥368.5m due beyond 12 months. Offsetting this, it had CN¥714.7m in cash and CN¥2.30b in receivables that were due within 12 months. So it can boast CN¥368.9m more liquid assets than total liabilities.

This surplus suggests that Sinoma Energy Conservation has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Sinoma Energy Conservation boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Sinoma Energy Conservation if management cannot prevent a repeat of the 70% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Sinoma Energy Conservation's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sinoma Energy Conservation has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Sinoma Energy Conservation burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sinoma Energy Conservation has CN¥269.0m in net cash and a decent-looking balance sheet. So while Sinoma Energy Conservation does not have a great balance sheet, it's certainly not too bad. 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. For instance, we've identified 4 warning signs for Sinoma Energy Conservation (1 shouldn't be ignored) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.