These 4 Measures Indicate That Loctek Ergonomic Technology (SZSE:300729) Is Using Debt Extensively

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Loctek Ergonomic Technology Corp. (SZSE:300729) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Loctek Ergonomic Technology

How Much Debt Does Loctek Ergonomic Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Loctek Ergonomic Technology had CN¥1.99b of debt, an increase on CN¥1.85b, over one year. However, it does have CN¥2.19b in cash offsetting this, leading to net cash of CN¥196.5m.

How Healthy Is Loctek Ergonomic Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Loctek Ergonomic Technology had liabilities of CN¥1.88b due within 12 months and liabilities of CN¥2.09b due beyond that. Offsetting these obligations, it had cash of CN¥2.19b as well as receivables valued at CN¥257.9m due within 12 months. So its liabilities total CN¥1.52b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Loctek Ergonomic Technology has a market capitalization of CN¥5.41b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Loctek Ergonomic Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Unfortunately, Loctek Ergonomic Technology saw its EBIT slide 8.6% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 Loctek Ergonomic Technology 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. Loctek Ergonomic Technology may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Loctek Ergonomic 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.

Summing Up

While Loctek Ergonomic Technology does have more liabilities than liquid assets, it also has net cash of CN¥196.5m. Despite the cash, we do find Loctek Ergonomic Technology's conversion of EBIT to free cash flow concerning, so we're not particularly comfortable with the stock. 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 4 warning signs with Loctek Ergonomic Technology (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.