Shanghai V-Test Semiconductor Tech (SHSE:688372) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Shanghai V-Test Semiconductor Tech. Co., Ltd. (SHSE:688372) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shanghai V-Test Semiconductor Tech

What Is Shanghai V-Test Semiconductor Tech's Net Debt?

As you can see below, at the end of September 2024, Shanghai V-Test Semiconductor Tech had CN¥1.36b of debt, up from CN¥723.1m a year ago. Click the image for more detail. However, it does have CN¥220.4m in cash offsetting this, leading to net debt of about CN¥1.13b.

How Strong Is Shanghai V-Test Semiconductor Tech's Balance Sheet?

The latest balance sheet data shows that Shanghai V-Test Semiconductor Tech had liabilities of CN¥582.0m due within a year, and liabilities of CN¥1.26b falling due after that. On the other hand, it had cash of CN¥220.4m and CN¥403.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.22b.

Since publicly traded Shanghai V-Test Semiconductor Tech shares are worth a total of CN¥6.75b, 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). 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).

Shanghai V-Test Semiconductor Tech has a debt to EBITDA ratio of 3.0 and its EBIT covered its interest expense 3.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Even worse, Shanghai V-Test Semiconductor Tech saw its EBIT tank 20% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Shanghai V-Test Semiconductor Tech 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, Shanghai V-Test Semiconductor Tech 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 Shanghai V-Test Semiconductor Tech's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. Overall, it seems to us that Shanghai V-Test Semiconductor Tech'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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Shanghai V-Test Semiconductor Tech (of which 1 is a bit concerning!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.