Is Sinomach Auto mobileLtd (SHSE:600335) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Sinomach Auto mobile Co.,Ltd (SHSE:600335) does have debt on its balance sheet. 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. 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. 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.

View our latest analysis for Sinomach Auto mobileLtd

What Is Sinomach Auto mobileLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Sinomach Auto mobileLtd had CN¥2.64b of debt in March 2024, down from CN¥3.21b, one year before. But on the other hand it also has CN¥3.17b in cash, leading to a CN¥526.4m net cash position.

How Strong Is Sinomach Auto mobileLtd's Balance Sheet?

According to the last reported balance sheet, Sinomach Auto mobileLtd had liabilities of CN¥19.9b due within 12 months, and liabilities of CN¥1.11b due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.17b as well as receivables valued at CN¥12.0b due within 12 months. So its liabilities total CN¥5.81b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Sinomach Auto mobileLtd is worth CN¥9.98b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Sinomach Auto mobileLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Shareholders should be aware that Sinomach Auto mobileLtd's EBIT was down 83% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sinomach Auto mobileLtd's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sinomach Auto mobileLtd 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, Sinomach Auto mobileLtd 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 Sinomach Auto mobileLtd does have more liabilities than liquid assets, it also has net cash of CN¥526.4m. Despite its cash we think that Sinomach Auto mobileLtd seems to struggle to grow its EBIT, so we are wary of the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Sinomach Auto mobileLtd you should be aware of, and 1 of them makes us a bit uncomfortable.

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.