Here's Why Suzhou Chunxing Precision Mechanical (SZSE:002547) Can Afford Some Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Suzhou Chunxing Precision Mechanical Co., Ltd. (SZSE:002547) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Suzhou Chunxing Precision Mechanical

How Much Debt Does Suzhou Chunxing Precision Mechanical Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Suzhou Chunxing Precision Mechanical had debt of CN¥2.23b, up from CN¥1.51b in one year. However, it does have CN¥459.7m in cash offsetting this, leading to net debt of about CN¥1.77b.

A Look At Suzhou Chunxing Precision Mechanical's Liabilities

Zooming in on the latest balance sheet data, we can see that Suzhou Chunxing Precision Mechanical had liabilities of CN¥3.58b due within 12 months and liabilities of CN¥1.19b due beyond that. Offsetting these obligations, it had cash of CN¥459.7m as well as receivables valued at CN¥624.0m due within 12 months. So it has liabilities totalling CN¥3.69b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Suzhou Chunxing Precision Mechanical has a market capitalization of CN¥6.94b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Suzhou Chunxing Precision Mechanical will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Suzhou Chunxing Precision Mechanical made a loss at the EBIT level, and saw its revenue drop to CN¥2.1b, which is a fall of 19%. We would much prefer see growth.

Caveat Emptor

While Suzhou Chunxing Precision Mechanical's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥284m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥275m of cash over the last year. So suffice it to say we do consider the stock to be risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Suzhou Chunxing Precision Mechanical you should know about.

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.