Here's Why Smartsens Technology (Shanghai) (SHSE:688213) Has A Meaningful Debt Burden

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.' 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. Importantly, Smartsens Technology (Shanghai) Co., Ltd. (SHSE:688213) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Smartsens Technology (Shanghai)

What Is Smartsens Technology (Shanghai)'s Debt?

As you can see below, at the end of September 2024, Smartsens Technology (Shanghai) had CN¥2.97b of debt, up from CN¥1.14b a year ago. Click the image for more detail. However, it does have CN¥893.8m in cash offsetting this, leading to net debt of about CN¥2.08b.

A Look At Smartsens Technology (Shanghai)'s Liabilities

We can see from the most recent balance sheet that Smartsens Technology (Shanghai) had liabilities of CN¥3.44b falling due within a year, and liabilities of CN¥446.1m due beyond that. On the other hand, it had cash of CN¥893.8m and CN¥782.6m worth of receivables due within a year. So its liabilities total CN¥2.21b more than the combination of its cash and short-term receivables.

Of course, Smartsens Technology (Shanghai) has a market capitalization of CN¥28.5b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt to EBITDA of 3.8 Smartsens Technology (Shanghai) has a fairly noticeable amount of debt. But the high interest coverage of 7.6 suggests it can easily service that debt. We also note that Smartsens Technology (Shanghai) improved its EBIT from a last year's loss to a positive CN¥478m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Smartsens Technology (Shanghai)'s ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Smartsens Technology (Shanghai) 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

Smartsens Technology (Shanghai)'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 interest cover is relatively strong. Taking the abovementioned factors together we do think Smartsens Technology (Shanghai)'s debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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, we've discovered 3 warning signs for Smartsens Technology (Shanghai) (2 don't sit too well with us!) that you should be aware of before investing here.

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.