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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Suzhou Chunxing Precision Mechanical Co., Ltd. (SZSE:002547) does use debt in its business. But the real question is whether this debt is making the company risky.

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Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Suzhou Chunxing Precision Mechanical's Net Debt?

As you can see below, at the end of September 2024, Suzhou Chunxing Precision Mechanical had CN¥2.23b of debt, up from CN¥1.51b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥459.7m, its net debt is less, at about CN¥1.77b.

How Healthy Is Suzhou Chunxing Precision Mechanical's Balance Sheet?

According to the last reported balance sheet, Suzhou Chunxing Precision Mechanical had liabilities of CN¥3.58b due within 12 months, and liabilities of CN¥1.19b due beyond 12 months. Offsetting this, it had CN¥459.7m in cash and CN¥624.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥3.69b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥4.96b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Suzhou Chunxing Precision Mechanical's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

See our latest analysis for Suzhou Chunxing Precision Mechanical

In the last year Suzhou Chunxing Precision Mechanical had a loss before interest and tax, and actually shrunk its revenue by 19%, to CN¥2.1b. That's not what we would hope to see.

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. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥275m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Suzhou Chunxing Precision Mechanical is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.