Here's Why Wuxi DK Electronic MaterialsLtd (SZSE:300842) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Wuxi DK Electronic Materials Co.,Ltd. (SZSE:300842) does use debt in its business. 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. 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. 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.

Check out our latest analysis for Wuxi DK Electronic MaterialsLtd

What Is Wuxi DK Electronic MaterialsLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Wuxi DK Electronic MaterialsLtd had debt of CN¥3.89b, up from CN¥1.96b in one year. On the flip side, it has CN¥2.13b in cash leading to net debt of about CN¥1.76b.

How Strong Is Wuxi DK Electronic MaterialsLtd's Balance Sheet?

The latest balance sheet data shows that Wuxi DK Electronic MaterialsLtd had liabilities of CN¥6.02b due within a year, and liabilities of CN¥71.5m falling due after that. Offsetting these obligations, it had cash of CN¥2.13b as well as receivables valued at CN¥4.30b due within 12 months. So it actually has CN¥337.3m more liquid assets than total liabilities.

This surplus suggests that Wuxi DK Electronic MaterialsLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Wuxi DK Electronic MaterialsLtd's debt is 2.6 times its EBITDA, and its EBIT cover its interest expense 6.7 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Wuxi DK Electronic MaterialsLtd's EBIT launched higher than Elon Musk, gaining a whopping 286% on last year. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Wuxi DK Electronic MaterialsLtd's ability to maintain a healthy balance sheet going forward. 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 always check how much of that EBIT is translated into free cash flow. During the last three years, Wuxi DK Electronic MaterialsLtd 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

Wuxi DK Electronic MaterialsLtd's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. Considering this range of data points, we think Wuxi DK Electronic MaterialsLtd 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. 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. Case in point: We've spotted 3 warning signs for Wuxi DK Electronic MaterialsLtd you should be aware of, and 2 of them can't be ignored.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.