Is Sinomach AutomobileLtd (SHSE:600335) A Risky Investment?

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.' 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. Importantly, Sinomach Automobile Co.,Ltd. (SHSE:600335) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sinomach AutomobileLtd

What Is Sinomach AutomobileLtd's Debt?

The image below, which you can click on for greater detail, shows that Sinomach AutomobileLtd had debt of CN¥1.70b at the end of June 2024, a reduction from CN¥3.60b over a year. However, its balance sheet shows it holds CN¥3.15b in cash, so it actually has CN¥1.45b net cash.

How Strong Is Sinomach AutomobileLtd's Balance Sheet?

The latest balance sheet data shows that Sinomach AutomobileLtd had liabilities of CN¥18.4b due within a year, and liabilities of CN¥1.03b falling due after that. On the other hand, it had cash of CN¥3.15b and CN¥10.8b worth of receivables due within a year. So its liabilities total CN¥5.50b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥8.93b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Sinomach AutomobileLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Sinomach AutomobileLtd's EBIT was down 70% 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. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sinomach AutomobileLtd 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sinomach AutomobileLtd 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, Sinomach AutomobileLtd 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 AutomobileLtd does have more liabilities than liquid assets, it also has net cash of CN¥1.45b. Despite its cash we think that Sinomach AutomobileLtd seems to struggle to grow its EBIT, so we are wary of the stock. 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. For instance, we've identified 4 warning signs for Sinomach AutomobileLtd (1 is concerning) you should be aware of.

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.