We Think Jiangsu Hongtian TechnologyLtd (SHSE:603800) Is Taking Some Risk With Its Debt

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. As with many other companies Jiangsu Hongtian Technology Co.,Ltd. (SHSE:603800) makes use of debt. But should shareholders be worried about its use of debt?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Jiangsu Hongtian TechnologyLtd

What Is Jiangsu Hongtian TechnologyLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Jiangsu Hongtian TechnologyLtd had CN¥975.6m of debt, an increase on CN¥598.0m, over one year. However, because it has a cash reserve of CN¥555.2m, its net debt is less, at about CN¥420.4m.

How Strong Is Jiangsu Hongtian TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Jiangsu Hongtian TechnologyLtd had liabilities of CN¥2.22b due within 12 months, and liabilities of CN¥587.6m due beyond 12 months. Offsetting this, it had CN¥555.2m in cash and CN¥1.08b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.17b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Jiangsu Hongtian TechnologyLtd is worth CN¥4.09b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Jiangsu Hongtian TechnologyLtd has net debt of just 1.5 times EBITDA, suggesting it could ramp leverage without breaking a sweat. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. Fortunately, Jiangsu Hongtian TechnologyLtd grew its EBIT by 3.9% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Jiangsu Hongtian TechnologyLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. During the last two years, Jiangsu Hongtian TechnologyLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Jiangsu Hongtian TechnologyLtd's ability to convert EBIT to free cash flow nor its level of total liabilities 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 Hongtian 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Jiangsu Hongtian TechnologyLtd .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com