Is Jiangsu Tongrun Equipment TechnologyLtd (SZSE:002150) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Jiangsu Tongrun Equipment Technology Co.,Ltd (SZSE:002150) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Jiangsu Tongrun Equipment TechnologyLtd

What Is Jiangsu Tongrun Equipment TechnologyLtd's Net Debt?

As you can see below, at the end of March 2024, Jiangsu Tongrun Equipment TechnologyLtd had CN¥1.03b of debt, up from CN¥41.0m a year ago. Click the image for more detail. However, it does have CN¥892.2m in cash offsetting this, leading to net debt of about CN¥139.0m.

How Strong Is Jiangsu Tongrun Equipment TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Jiangsu Tongrun Equipment TechnologyLtd had liabilities of CN¥1.50b due within 12 months, and liabilities of CN¥728.7m due beyond 12 months. Offsetting this, it had CN¥892.2m in cash and CN¥826.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥505.3m.

Since publicly traded Jiangsu Tongrun Equipment TechnologyLtd shares are worth a total of CN¥4.15b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Jiangsu Tongrun Equipment TechnologyLtd has a low net debt to EBITDA ratio of only 0.62. And its EBIT easily covers its interest expense, being 14.3 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Jiangsu Tongrun Equipment TechnologyLtd's EBIT dived 15%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Jiangsu Tongrun Equipment TechnologyLtd'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, Jiangsu Tongrun Equipment TechnologyLtd actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Neither Jiangsu Tongrun Equipment TechnologyLtd's ability to convert EBIT to free cash flow nor its EBIT growth rate gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. We think that Jiangsu Tongrun Equipment TechnologyLtd's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example Jiangsu Tongrun Equipment TechnologyLtd has 3 warning signs (and 2 which make us uncomfortable) we think you should know about.

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.