Smartsens Technology (Shanghai) (SHSE:688213) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Smartsens Technology (Shanghai) Co., Ltd. (SHSE:688213) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for Smartsens Technology (Shanghai)

How Much Debt Does Smartsens Technology (Shanghai) Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Smartsens Technology (Shanghai) had debt of CN¥2.36b, up from CN¥1.61b in one year. However, because it has a cash reserve of CN¥843.0m, its net debt is less, at about CN¥1.51b.

How Strong Is Smartsens Technology (Shanghai)'s Balance Sheet?

According to the last reported balance sheet, Smartsens Technology (Shanghai) had liabilities of CN¥2.72b due within 12 months, and liabilities of CN¥352.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥843.0m as well as receivables valued at CN¥751.4m due within 12 months. So it has liabilities totalling CN¥1.48b more than its cash and near-term receivables, combined.

Since publicly traded Smartsens Technology (Shanghai) shares are worth a total of CN¥20.3b, it seems unlikely that this level of liabilities would be a major threat. 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.

Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 10.6 hit our confidence in Smartsens Technology (Shanghai) like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for Smartsens Technology (Shanghai) is that it turned last year's EBIT loss into a gain of CN¥78m, over the last twelve months. 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 Smartsens Technology (Shanghai) 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Smartsens Technology (Shanghai)'s net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. Once we consider all the factors above, together, it seems to us that Smartsens Technology (Shanghai)'s debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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 example - Smartsens Technology (Shanghai) has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.