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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Fujian Sunner Development Co., Ltd. (SZSE:002299) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Fujian Sunner Development

How Much Debt Does Fujian Sunner Development Carry?

As you can see below, at the end of June 2024, Fujian Sunner Development had CN¥7.68b of debt, up from CN¥6.97b a year ago. Click the image for more detail. However, it does have CN¥2.29b in cash offsetting this, leading to net debt of about CN¥5.40b.

How Healthy Is Fujian Sunner Development's Balance Sheet?

According to the last reported balance sheet, Fujian Sunner Development had liabilities of CN¥11.2b due within 12 months, and liabilities of CN¥942.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.29b as well as receivables valued at CN¥920.7m due within 12 months. So it has liabilities totalling CN¥8.97b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥13.4b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Fujian Sunner Development's debt is 2.9 times its EBITDA, and its EBIT cover its interest expense 4.6 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Shareholders should be aware that Fujian Sunner Development's EBIT was down 58% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 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 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 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

We'd go so far as to say Fujian Sunner Development's EBIT growth rate was disappointing. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Fujian Sunner Development's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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 3 warning signs for Fujian Sunner Development you should know about.

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.