Is Fujian Tianma Science and Technology Group (SHSE:603668) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Fujian Tianma Science and Technology Group Co., Ltd (SHSE:603668) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See 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 September 2024 Fujian Tianma Science and Technology Group had debt of CN¥3.47b, up from CN¥3.32b in one year. However, it also had CN¥544.7m in cash, and so its net debt is CN¥2.92b.

How Strong Is Fujian Tianma Science and Technology Group's Balance Sheet?

According to the last reported balance sheet, Fujian Tianma Science and Technology Group had liabilities of CN¥4.79b due within 12 months, and liabilities of CN¥1.42b due beyond 12 months. Offsetting this, it had CN¥544.7m in cash and CN¥642.4m in receivables that were due within 12 months. So it has liabilities totalling CN¥5.03b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥6.57b, so it does suggest shareholders should keep an eye on Fujian Tianma Science and Technology Group's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.0 times and a disturbingly high net debt to EBITDA ratio of 7.3 hit our confidence in Fujian Tianma Science and Technology Group like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Fujian Tianma Science and Technology Group is that it turned last year's EBIT loss into a gain of CN¥158m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Fujian Tianma Science and Technology Group'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, 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

On the face of it, Fujian Tianma Science and Technology Group's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that Fujian Tianma Science and Technology Group's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Fujian Tianma Science and Technology Group (of which 3 are significant!) 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.