Is Shanghai Fullhan Microelectronics (SZSE:300613) A Risky Investment?

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.' 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. Importantly, Shanghai Fullhan Microelectronics Co., Ltd. (SZSE:300613) does carry debt. But the real question is whether this debt is making the company risky.

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. 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. 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 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 Shanghai Fullhan Microelectronics

What Is Shanghai Fullhan Microelectronics's Net Debt?

The image below, which you can click on for greater detail, shows that Shanghai Fullhan Microelectronics had debt of CN¥580.9m at the end of March 2024, a reduction from CN¥648.2m over a year. However, it does have CN¥1.88b in cash offsetting this, leading to net cash of CN¥1.30b.

How Strong Is Shanghai Fullhan Microelectronics' Balance Sheet?

We can see from the most recent balance sheet that Shanghai Fullhan Microelectronics had liabilities of CN¥216.7m falling due within a year, and liabilities of CN¥580.7m due beyond that. On the other hand, it had cash of CN¥1.88b and CN¥306.1m worth of receivables due within a year. So it actually has CN¥1.38b more liquid assets than total liabilities.

It's good to see that Shanghai Fullhan Microelectronics has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Shanghai Fullhan Microelectronics boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Shanghai Fullhan Microelectronics's load is not too heavy, because its EBIT was down 48% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shanghai Fullhan Microelectronics's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shanghai Fullhan Microelectronics may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Shanghai Fullhan Microelectronics actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Fullhan Microelectronics has net cash of CN¥1.30b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥485m, being 107% of its EBIT. So is Shanghai Fullhan Microelectronics's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Shanghai Fullhan Microelectronics has 2 warning signs we think you should be aware of.

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.