Hangzhou Silan MicroelectronicsLtd (SHSE:600460) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Hangzhou Silan Microelectronics Co.,Ltd (SHSE:600460) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 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 Hangzhou Silan MicroelectronicsLtd

What Is Hangzhou Silan MicroelectronicsLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Hangzhou Silan MicroelectronicsLtd had debt of CN¥5.48b at the end of June 2024, a reduction from CN¥5.73b over a year. On the flip side, it has CN¥4.90b in cash leading to net debt of about CN¥581.9m.

How Healthy Is Hangzhou Silan MicroelectronicsLtd's Balance Sheet?

According to the last reported balance sheet, Hangzhou Silan MicroelectronicsLtd had liabilities of CN¥5.83b due within 12 months, and liabilities of CN¥3.93b due beyond 12 months. On the other hand, it had cash of CN¥4.90b and CN¥3.91b worth of receivables due within a year. So it has liabilities totalling CN¥946.8m more than its cash and near-term receivables, combined.

Since publicly traded Hangzhou Silan MicroelectronicsLtd shares are worth a total of CN¥30.0b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Hangzhou Silan MicroelectronicsLtd has a low net debt to EBITDA ratio of only 0.42. And its EBIT easily covers its interest expense, being 10.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact Hangzhou Silan MicroelectronicsLtd's saving grace is its low debt levels, because its EBIT has tanked 60% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hangzhou Silan MicroelectronicsLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Hangzhou Silan MicroelectronicsLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Both Hangzhou Silan MicroelectronicsLtd's EBIT growth rate and its conversion of EBIT to free cash flow were discouraging. But at least its interest cover is a gleaming silver lining to those clouds. Taking the abovementioned factors together we do think Hangzhou Silan MicroelectronicsLtd's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Case in point: We've spotted 2 warning signs for Hangzhou Silan MicroelectronicsLtd you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.