Fujian Kuncai Material Technology (SHSE:603826) Has A Somewhat Strained Balance Sheet

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.' 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. As with many other companies Fujian Kuncai Material Technology Co., Ltd. (SHSE:603826) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Fujian Kuncai Material Technology

How Much Debt Does Fujian Kuncai Material Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Fujian Kuncai Material Technology had CN¥1.87b of debt, an increase on CN¥1.76b, over one year. On the flip side, it has CN¥128.3m in cash leading to net debt of about CN¥1.74b.

How Strong Is Fujian Kuncai Material Technology's Balance Sheet?

The latest balance sheet data shows that Fujian Kuncai Material Technology had liabilities of CN¥2.04b due within a year, and liabilities of CN¥776.2m falling due after that. Offsetting this, it had CN¥128.3m in cash and CN¥339.6m in receivables that were due within 12 months. So its liabilities total CN¥2.35b more than the combination of its cash and short-term receivables.

Given Fujian Kuncai Material Technology has a market capitalization of CN¥17.9b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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

Fujian Kuncai Material Technology has a rather high debt to EBITDA ratio of 5.9 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 2.5 times, suggesting it can responsibly service its obligations. Looking on the bright side, Fujian Kuncai Material Technology boosted its EBIT by a silky 67% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Fujian Kuncai Material Technology'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 always check how much of that EBIT is translated into free cash flow. During the last three years, Fujian Kuncai Material Technology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Fujian Kuncai Material Technology's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that Fujian Kuncai Material Technology 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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Fujian Kuncai Material Technology .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.