Is Shanghai Putailai New Energy TechnologyLtd (SHSE:603659) 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.' 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 can see that Shanghai Putailai New Energy Technology Co.,Ltd. (SHSE:603659) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shanghai Putailai New Energy TechnologyLtd

What Is Shanghai Putailai New Energy TechnologyLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shanghai Putailai New Energy TechnologyLtd had CN¥11.4b of debt, an increase on CN¥9.61b, over one year. However, because it has a cash reserve of CN¥9.07b, its net debt is less, at about CN¥2.29b.

A Look At Shanghai Putailai New Energy TechnologyLtd's Liabilities

According to the last reported balance sheet, Shanghai Putailai New Energy TechnologyLtd had liabilities of CN¥16.6b due within 12 months, and liabilities of CN¥6.65b due beyond 12 months. Offsetting these obligations, it had cash of CN¥9.07b as well as receivables valued at CN¥5.58b due within 12 months. So it has liabilities totalling CN¥8.63b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Shanghai Putailai New Energy TechnologyLtd has a market capitalization of CN¥39.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Shanghai Putailai New Energy TechnologyLtd's net debt is only 1.0 times its EBITDA. And its EBIT covers its interest expense a whopping 31.3 times over. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Shanghai Putailai New Energy TechnologyLtd's load is not too heavy, because its EBIT was down 53% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Putailai New Energy TechnologyLtd'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Shanghai Putailai New Energy TechnologyLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Shanghai Putailai New Energy TechnologyLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Shanghai Putailai New Energy TechnologyLtd stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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 Shanghai Putailai New Energy TechnologyLtd .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.