These 4 Measures Indicate That Shanghai Putailai New Energy TechnologyLtd (SHSE:603659) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Shanghai Putailai New Energy Technology Co.,Ltd. (SHSE:603659) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Shanghai Putailai New Energy TechnologyLtd

What Is Shanghai Putailai New Energy TechnologyLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Shanghai Putailai New Energy TechnologyLtd had debt of CN¥10.1b, up from CN¥6.95b in one year. However, because it has a cash reserve of CN¥8.28b, its net debt is less, at about CN¥1.78b.

How Strong Is Shanghai Putailai New Energy TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Shanghai Putailai New Energy TechnologyLtd had liabilities of CN¥17.5b due within 12 months, and liabilities of CN¥5.13b due beyond 12 months. Offsetting this, it had CN¥8.28b in cash and CN¥5.42b in receivables that were due within 12 months. So it has liabilities totalling CN¥8.93b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Shanghai Putailai New Energy TechnologyLtd is worth CN¥27.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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.

Shanghai Putailai New Energy TechnologyLtd has a low net debt to EBITDA ratio of only 0.69. And its EBIT easily covers its interest expense, being 44.4 times the size. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for Shanghai Putailai New Energy TechnologyLtd if management cannot prevent a repeat of the 47% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanghai Putailai New Energy TechnologyLtd can strengthen its balance sheet over time. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Shanghai Putailai New Energy TechnologyLtd 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 Shanghai Putailai New Energy TechnologyLtd'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. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Shanghai Putailai New Energy TechnologyLtd's debt is making it 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. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Shanghai Putailai New Energy TechnologyLtd (including 1 which is concerning) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com