Is Union Semiconductor (Hefei) (SHSE:688403) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Union Semiconductor (Hefei) Co., Ltd. (SHSE:688403) does carry debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Union Semiconductor (Hefei)

What Is Union Semiconductor (Hefei)'s Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Union Semiconductor (Hefei) had CN¥1.14b of debt, an increase on CN¥185.6m, over one year. However, it does have CN¥915.8m in cash offsetting this, leading to net debt of about CN¥224.6m.

A Look At Union Semiconductor (Hefei)'s Liabilities

The latest balance sheet data shows that Union Semiconductor (Hefei) had liabilities of CN¥213.5m due within a year, and liabilities of CN¥1.19b falling due after that. On the other hand, it had cash of CN¥915.8m and CN¥264.4m worth of receivables due within a year. So its liabilities total CN¥227.7m more than the combination of its cash and short-term receivables.

Since publicly traded Union Semiconductor (Hefei) shares are worth a total of CN¥7.77b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Union Semiconductor (Hefei)'s net debt is only 0.48 times its EBITDA. And its EBIT covers its interest expense a whopping 32.3 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that Union Semiconductor (Hefei) grew its EBIT by 11% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Union Semiconductor (Hefei)'s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Union Semiconductor (Hefei) burned a lot of cash. 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

Based on what we've seen Union Semiconductor (Hefei) is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Union Semiconductor (Hefei) is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Case in point: We've spotted 1 warning sign for Union Semiconductor (Hefei) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.