Is Do-Fluoride New Materials (SZSE:002407) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Do-Fluoride New Materials Co., Ltd. (SZSE:002407) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Do-Fluoride New Materials

How Much Debt Does Do-Fluoride New Materials Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Do-Fluoride New Materials had debt of CN¥5.39b, up from CN¥4.66b in one year. However, its balance sheet shows it holds CN¥6.76b in cash, so it actually has CN¥1.36b net cash.

How Strong Is Do-Fluoride New Materials' Balance Sheet?

We can see from the most recent balance sheet that Do-Fluoride New Materials had liabilities of CN¥5.77b falling due within a year, and liabilities of CN¥4.94b due beyond that. Offsetting these obligations, it had cash of CN¥6.76b as well as receivables valued at CN¥3.05b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥903.9m.

Since publicly traded Do-Fluoride New Materials shares are worth a total of CN¥15.4b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Do-Fluoride New Materials also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Do-Fluoride New Materials if management cannot prevent a repeat of the 64% 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. 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 Do-Fluoride New Materials's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Do-Fluoride New Materials may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Do-Fluoride New Materials 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.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Do-Fluoride New Materials has CN¥1.36b in net cash. So although we see some areas for improvement, we're not too worried about Do-Fluoride New Materials's balance sheet. 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. For example - Do-Fluoride New Materials has 3 warning signs we think you should be aware of.

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.