Is Yunnan Nantian Electronics InformationLtd (SZSE:000948) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Yunnan Nantian Electronics Information Co.,Ltd. (SZSE:000948) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Yunnan Nantian Electronics InformationLtd

What Is Yunnan Nantian Electronics InformationLtd's Debt?

The chart below, which you can click on for greater detail, shows that Yunnan Nantian Electronics InformationLtd had CN¥1.44b in debt in September 2023; about the same as the year before. On the flip side, it has CN¥1.21b in cash leading to net debt of about CN¥239.0m.

How Strong Is Yunnan Nantian Electronics InformationLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yunnan Nantian Electronics InformationLtd had liabilities of CN¥5.16b due within 12 months and liabilities of CN¥1.04b due beyond that. On the other hand, it had cash of CN¥1.21b and CN¥2.47b worth of receivables due within a year. So it has liabilities totalling CN¥2.52b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Yunnan Nantian Electronics InformationLtd has a market capitalization of CN¥5.40b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 0.95 and interest cover of 7.0 times, it seems to us that Yunnan Nantian Electronics InformationLtd is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. And we also note warmly that Yunnan Nantian Electronics InformationLtd grew its EBIT by 13% 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 Yunnan Nantian Electronics InformationLtd'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Yunnan Nantian Electronics InformationLtd 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

Yunnan Nantian Electronics InformationLtd's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its net debt to EBITDA is relatively strong. Looking at all the angles mentioned above, it does seem to us that Yunnan Nantian Electronics InformationLtd is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Yunnan Nantian Electronics InformationLtd's earnings per share history for free.

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.