Forehope Electronic (Ningbo) (SHSE:688362) Has A Somewhat Strained Balance Sheet

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.' 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. We can see that Forehope Electronic (Ningbo) Co., Ltd. (SHSE:688362) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Forehope Electronic (Ningbo)

How Much Debt Does Forehope Electronic (Ningbo) Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Forehope Electronic (Ningbo) had CN¥5.57b of debt, an increase on CN¥3.77b, over one year. On the flip side, it has CN¥2.01b in cash leading to net debt of about CN¥3.56b.

How Strong Is Forehope Electronic (Ningbo)'s Balance Sheet?

We can see from the most recent balance sheet that Forehope Electronic (Ningbo) had liabilities of CN¥3.54b falling due within a year, and liabilities of CN¥6.24b due beyond that. Offsetting this, it had CN¥2.01b in cash and CN¥681.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥7.09b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Forehope Electronic (Ningbo) has a market capitalization of CN¥14.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Forehope Electronic (Ningbo) shareholders face the double whammy of a high net debt to EBITDA ratio (5.4), and fairly weak interest coverage, since EBIT is just 0.78 times the interest expense. The debt burden here is substantial. One redeeming factor for Forehope Electronic (Ningbo) is that it turned last year's EBIT loss into a gain of CN¥145m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Forehope Electronic (Ningbo) can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, Forehope Electronic (Ningbo) 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

On the face of it, Forehope Electronic (Ningbo)'s interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that Forehope Electronic (Ningbo)'s balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 Forehope Electronic (Ningbo) (2 shouldn't be ignored!) that you should be aware of before investing here.

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.