Is Shenzhen Tianyuan DIC Information Technology (SZSE:300047) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Shenzhen Tianyuan DIC Information Technology Co., Ltd. (SZSE:300047) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Shenzhen Tianyuan DIC Information Technology

What Is Shenzhen Tianyuan DIC Information Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shenzhen Tianyuan DIC Information Technology had CN¥1.61b of debt in September 2023, down from CN¥1.73b, one year before. However, because it has a cash reserve of CN¥134.3m, its net debt is less, at about CN¥1.47b.

How Healthy Is Shenzhen Tianyuan DIC Information Technology's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Tianyuan DIC Information Technology had liabilities of CN¥2.25b falling due within a year, and liabilities of CN¥127.5m due beyond that. Offsetting this, it had CN¥134.3m in cash and CN¥1.75b in receivables that were due within 12 months. So its liabilities total CN¥497.7m more than the combination of its cash and short-term receivables.

Of course, Shenzhen Tianyuan DIC Information Technology has a market capitalization of CN¥4.69b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 39.6 hit our confidence in Shenzhen Tianyuan DIC Information Technology like a one-two punch to the gut. The debt burden here is substantial. Even worse, Shenzhen Tianyuan DIC Information Technology saw its EBIT tank 29% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shenzhen Tianyuan DIC Information Technology's earnings that will influence how the balance sheet holds up in the future. 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Shenzhen Tianyuan DIC Information Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Shenzhen Tianyuan DIC Information Technology'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 on the bright side, its level of total liabilities is a good sign, and makes us more optimistic. Overall, it seems to us that Shenzhen Tianyuan DIC Information Technology's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 Shenzhen Tianyuan DIC Information Technology you should be aware of, and 2 of them are a bit concerning.

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.