Is Wafer Works (Shanghai) (SHSE:688584) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Wafer Works (Shanghai) Co., Ltd. (SHSE:688584) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Wafer Works (Shanghai)

How Much Debt Does Wafer Works (Shanghai) Carry?

As you can see below, Wafer Works (Shanghai) had CN¥510.0m of debt at March 2024, down from CN¥801.1m a year prior. But it also has CN¥1.72b in cash to offset that, meaning it has CN¥1.21b net cash.

How Strong Is Wafer Works (Shanghai)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wafer Works (Shanghai) had liabilities of CN¥540.2m due within 12 months and liabilities of CN¥221.9m due beyond that. On the other hand, it had cash of CN¥1.72b and CN¥235.1m worth of receivables due within a year. So it can boast CN¥1.20b more liquid assets than total liabilities.

This surplus suggests that Wafer Works (Shanghai) has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Wafer Works (Shanghai) boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Wafer Works (Shanghai)'s load is not too heavy, because its EBIT was down 54% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Wafer Works (Shanghai) will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Wafer Works (Shanghai) has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Wafer Works (Shanghai) recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Wafer Works (Shanghai) has net cash of CN¥1.21b, as well as more liquid assets than liabilities. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in CN¥156m. So we are not troubled with Wafer Works (Shanghai)'s debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Wafer Works (Shanghai) you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com