These 4 Measures Indicate That Jolywood (Suzhou) SunwattLtd (SZSE:300393) Is Using Debt Extensively

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Jolywood (Suzhou) Sunwatt Co.,Ltd. (SZSE:300393) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Jolywood (Suzhou) SunwattLtd

What Is Jolywood (Suzhou) SunwattLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Jolywood (Suzhou) SunwattLtd had CN¥6.67b of debt, an increase on CN¥4.51b, over one year. However, it does have CN¥2.09b in cash offsetting this, leading to net debt of about CN¥4.58b.

How Strong Is Jolywood (Suzhou) SunwattLtd's Balance Sheet?

According to the last reported balance sheet, Jolywood (Suzhou) SunwattLtd had liabilities of CN¥7.88b due within 12 months, and liabilities of CN¥3.87b due beyond 12 months. On the other hand, it had cash of CN¥2.09b and CN¥3.99b worth of receivables due within a year. So it has liabilities totalling CN¥5.67b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥6.37b, so it does suggest shareholders should keep an eye on Jolywood (Suzhou) SunwattLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely Jolywood (Suzhou) SunwattLtd has a sky high EBITDA ratio of 7.6, implying high debt, but a strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Shareholders should be aware that Jolywood (Suzhou) SunwattLtd's EBIT was down 59% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Jolywood (Suzhou) SunwattLtd 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. During the last three years, Jolywood (Suzhou) SunwattLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Jolywood (Suzhou) SunwattLtd'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 it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that Jolywood (Suzhou) SunwattLtd'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. Case in point: We've spotted 4 warning signs for Jolywood (Suzhou) SunwattLtd 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.

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