Here's Why Fujian Tianma Science and Technology Group (SHSE:603668) Is Weighed Down By Its Debt Load

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 note that Fujian Tianma Science and Technology Group Co., Ltd (SHSE:603668) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Fujian Tianma Science and Technology Group

What Is Fujian Tianma Science and Technology Group's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Fujian Tianma Science and Technology Group had debt of CN¥3.32b, up from CN¥2.90b in one year. However, because it has a cash reserve of CN¥512.2m, its net debt is less, at about CN¥2.81b.

A Look At Fujian Tianma Science and Technology Group's Liabilities

The latest balance sheet data shows that Fujian Tianma Science and Technology Group had liabilities of CN¥4.89b due within a year, and liabilities of CN¥1.52b falling due after that. Offsetting this, it had CN¥512.2m in cash and CN¥597.2m in receivables that were due within 12 months. So its liabilities total CN¥5.30b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥7.06b, so it does suggest shareholders should keep an eye on Fujian Tianma Science and Technology Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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

Fujian Tianma Science and Technology Group shareholders face the double whammy of a high net debt to EBITDA ratio (12.5), and fairly weak interest coverage, since EBIT is just 0.076 times the interest expense. The debt burden here is substantial. Even worse, Fujian Tianma Science and Technology Group saw its EBIT tank 95% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Fujian Tianma Science and Technology Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Fujian Tianma Science and Technology Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Fujian Tianma Science and Technology Group's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its net debt to EBITDA also fails to instill confidence. Taking into account all the aforementioned factors, it looks like Fujian Tianma Science and Technology Group has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Fujian Tianma Science and Technology Group (of which 1 is concerning!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.