We Think Zhejiang Sunoren Solar TechnologyLtd (SHSE:603105) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Zhejiang Sunoren Solar Technology Co.,Ltd. (SHSE:603105) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Zhejiang Sunoren Solar TechnologyLtd

How Much Debt Does Zhejiang Sunoren Solar TechnologyLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Zhejiang Sunoren Solar TechnologyLtd had CN¥1.95b of debt, an increase on CN¥1.47b, over one year. However, it also had CN¥607.9m in cash, and so its net debt is CN¥1.34b.

How Healthy Is Zhejiang Sunoren Solar TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Zhejiang Sunoren Solar TechnologyLtd had liabilities of CN¥557.8m due within 12 months, and liabilities of CN¥1.67b due beyond 12 months. On the other hand, it had cash of CN¥607.9m and CN¥241.7m worth of receivables due within a year. So it has liabilities totalling CN¥1.38b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Zhejiang Sunoren Solar TechnologyLtd is worth CN¥5.29b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Zhejiang Sunoren Solar TechnologyLtd has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 4.1 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Given the debt load, it's hardly ideal that Zhejiang Sunoren Solar TechnologyLtd's EBIT was pretty flat over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhejiang Sunoren Solar TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, Zhejiang Sunoren Solar TechnologyLtd actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Zhejiang Sunoren Solar TechnologyLtd's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its level of total liabilities is relatively strong. Taking the abovementioned factors together we do think Zhejiang Sunoren Solar TechnologyLtd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Zhejiang Sunoren Solar TechnologyLtd 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.