Is Do-Fluoride New Materials (SZSE:002407) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Do-Fluoride New Materials Co., Ltd. (SZSE:002407) 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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Do-Fluoride New Materials

How Much Debt Does Do-Fluoride New Materials Carry?

As you can see below, at the end of June 2024, Do-Fluoride New Materials had CN¥6.11b of debt, up from CN¥5.42b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥6.28b in cash, so it actually has CN¥172.6m net cash.

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

According to the last reported balance sheet, Do-Fluoride New Materials had liabilities of CN¥6.61b due within 12 months, and liabilities of CN¥4.63b due beyond 12 months. On the other hand, it had cash of CN¥6.28b and CN¥3.03b worth of receivables due within a year. So its liabilities total CN¥1.93b more than the combination of its cash and short-term receivables.

Since publicly traded Do-Fluoride New Materials shares are worth a total of CN¥14.2b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Do-Fluoride New Materials boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Do-Fluoride New Materials if management cannot prevent a repeat of the 55% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Do-Fluoride New Materials can strengthen its balance sheet over time. 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. While Do-Fluoride New Materials has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. 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 Do-Fluoride New Materials does have more liabilities than liquid assets, it also has net cash of CN¥172.6m. So while Do-Fluoride New Materials does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Do-Fluoride New Materials is showing 3 warning signs in our investment analysis , and 2 of those make us uncomfortable...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.