Is Sichuan Changhong ElectricLtd (SHSE:600839) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Sichuan Changhong Electric Co.,Ltd. (SHSE:600839) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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.

Check out our latest analysis for Sichuan Changhong ElectricLtd

What Is Sichuan Changhong ElectricLtd's Debt?

As you can see below, Sichuan Changhong ElectricLtd had CN¥18.8b of debt at September 2023, down from CN¥19.8b a year prior. However, its balance sheet shows it holds CN¥23.0b in cash, so it actually has CN¥4.25b net cash.

How Strong Is Sichuan Changhong ElectricLtd's Balance Sheet?

The latest balance sheet data shows that Sichuan Changhong ElectricLtd had liabilities of CN¥59.7b due within a year, and liabilities of CN¥5.97b falling due after that. Offsetting these obligations, it had cash of CN¥23.0b as well as receivables valued at CN¥18.5b due within 12 months. So its liabilities total CN¥24.2b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥28.1b, so it does suggest shareholders should keep an eye on Sichuan Changhong ElectricLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Sichuan Changhong ElectricLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Sichuan Changhong ElectricLtd grew its EBIT by 71% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sichuan Changhong ElectricLtd will need earnings to service that debt. 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. Sichuan Changhong ElectricLtd 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, Sichuan Changhong ElectricLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although Sichuan Changhong ElectricLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥4.25b. The cherry on top was that in converted 239% of that EBIT to free cash flow, bringing in CN¥1.6b. So we don't think Sichuan Changhong ElectricLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Sichuan Changhong ElectricLtd .

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.

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.