These 4 Measures Indicate That Satellite ChemicalLtd (SZSE:002648) Is Using Debt Reasonably Well

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.' 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. We note that Satellite Chemical Co.,Ltd. (SZSE:002648) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Satellite ChemicalLtd

What Is Satellite ChemicalLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Satellite ChemicalLtd had CN¥14.0b of debt in March 2024, down from CN¥15.7b, one year before. However, it also had CN¥5.92b in cash, and so its net debt is CN¥8.10b.

How Strong Is Satellite ChemicalLtd's Balance Sheet?

We can see from the most recent balance sheet that Satellite ChemicalLtd had liabilities of CN¥13.2b falling due within a year, and liabilities of CN¥26.0b due beyond that. Offsetting these obligations, it had cash of CN¥5.92b as well as receivables valued at CN¥2.04b due within 12 months. So it has liabilities totalling CN¥31.3b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Satellite ChemicalLtd has a market capitalization of CN¥62.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Satellite ChemicalLtd's net debt is only 0.93 times its EBITDA. And its EBIT covers its interest expense a whopping 22.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Satellite ChemicalLtd grew its EBIT by 90% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Satellite ChemicalLtd'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Satellite ChemicalLtd recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Satellite ChemicalLtd's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its level of total liabilities. When we consider the range of factors above, it looks like Satellite ChemicalLtd is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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 1 warning sign we've spotted with Satellite ChemicalLtd .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.