Here's Why Fujian Sunner Development (SZSE:002299) Has A Meaningful Debt Burden

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Fujian Sunner Development Co., Ltd. (SZSE:002299) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Fujian Sunner Development

What Is Fujian Sunner Development's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Fujian Sunner Development had CN¥8.97b of debt, an increase on CN¥6.14b, over one year. However, because it has a cash reserve of CN¥1.85b, its net debt is less, at about CN¥7.12b.

A Look At Fujian Sunner Development's Liabilities

We can see from the most recent balance sheet that Fujian Sunner Development had liabilities of CN¥11.7b falling due within a year, and liabilities of CN¥1.53b due beyond that. Offsetting these obligations, it had cash of CN¥1.85b as well as receivables valued at CN¥757.6m due within 12 months. So its liabilities total CN¥10.6b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Fujian Sunner Development has a market capitalization of CN¥20.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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 Sunner Development has a debt to EBITDA ratio of 3.5 and its EBIT covered its interest expense 6.2 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably Fujian Sunner Development's EBIT was pretty flat over the last year. We would prefer to see some earnings growth, because that always helps diminish debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Fujian Sunner Development'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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Fujian Sunner Development produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Both Fujian Sunner Development's net debt to EBITDA and its level of total liabilities were discouraging. But its not so bad at converting EBIT to free cash flow. Looking at all the angles mentioned above, it does seem to us that Fujian Sunner Development is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Case in point: We've spotted 2 warning signs for Fujian Sunner Development you should be aware of.

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.

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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.