Is Hangzhou Silan MicroelectronicsLtd (SHSE:600460) Using Too Much 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 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. We can see that Hangzhou Silan Microelectronics Co.,Ltd (SHSE:600460) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hangzhou Silan MicroelectronicsLtd

What Is Hangzhou Silan MicroelectronicsLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Hangzhou Silan MicroelectronicsLtd had CN¥5.70b of debt, an increase on CN¥5.02b, over one year. However, it does have CN¥5.15b in cash offsetting this, leading to net debt of about CN¥549.9m.

How Healthy Is Hangzhou Silan MicroelectronicsLtd's Balance Sheet?

According to the last reported balance sheet, Hangzhou Silan MicroelectronicsLtd had liabilities of CN¥5.18b due within 12 months, and liabilities of CN¥4.38b due beyond 12 months. Offsetting these obligations, it had cash of CN¥5.15b as well as receivables valued at CN¥3.62b due within 12 months. So it has liabilities totalling CN¥787.5m more than its cash and near-term receivables, combined.

Of course, Hangzhou Silan MicroelectronicsLtd has a market capitalization of CN¥31.2b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Hangzhou Silan MicroelectronicsLtd's net debt is only 0.37 times its EBITDA. And its EBIT covers its interest expense a whopping 15.6 times over. 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 39% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. 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. Over the last three years, Hangzhou Silan MicroelectronicsLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We feel some trepidation about Hangzhou Silan MicroelectronicsLtd's difficulty EBIT growth rate, but we've got positives to focus on, too. For example, its interest cover and net debt to EBITDA give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that Hangzhou Silan MicroelectronicsLtd is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Hangzhou Silan MicroelectronicsLtd has 1 warning sign we think 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.

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.

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