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.' 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 Shanghai Putailai New Energy Technology Co.,Ltd. (SHSE:603659) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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

The image below, which you can click on for greater detail, shows that at September 2024 Shanghai Putailai New Energy TechnologyLtd had debt of CN¥11.4b, up from CN¥9.61b in one year. On the flip side, it has CN¥9.07b in cash leading to net debt of about CN¥2.29b.

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

Zooming in on the latest balance sheet data, we can see that Shanghai Putailai New Energy TechnologyLtd had liabilities of CN¥16.6b due within 12 months and liabilities of CN¥6.65b due beyond that. Offsetting this, it had CN¥9.07b in cash and CN¥5.58b in receivables that were 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¥38.8b, 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.

View our latest analysis for Shanghai Putailai New Energy TechnologyLtd

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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 has a low net debt to EBITDA ratio of only 1.0. And its EBIT easily covers its interest expense, being 31.3 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact Shanghai Putailai New Energy TechnologyLtd's saving grace is its low debt levels, because its EBIT has tanked 53% in the last twelve months. 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 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 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. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Shanghai Putailai New Energy TechnologyLtd is showing 2 warning signs in our investment analysis , you should know about...

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.

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

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.