Shenzhen Tianyuan DIC Information Technology (SZSE:300047) Has A Somewhat Strained Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Shenzhen Tianyuan DIC Information Technology Co., Ltd. (SZSE:300047) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shenzhen Tianyuan DIC Information Technology

What Is Shenzhen Tianyuan DIC Information Technology's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Shenzhen Tianyuan DIC Information Technology had debt of CN¥2.11b, up from CN¥1.61b in one year. On the flip side, it has CN¥293.6m in cash leading to net debt of about CN¥1.81b.

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

According to the last reported balance sheet, Shenzhen Tianyuan DIC Information Technology had liabilities of CN¥2.62b due within 12 months, and liabilities of CN¥192.8m due beyond 12 months. Offsetting this, it had CN¥293.6m in cash and CN¥1.90b in receivables that were due within 12 months. So it has liabilities totalling CN¥613.9m more than its cash and near-term receivables, combined.

Since publicly traded Shenzhen Tianyuan DIC Information Technology shares are worth a total of CN¥8.95b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

With a net debt to EBITDA ratio of 17.1, it's fair to say Shenzhen Tianyuan DIC Information Technology does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 2.6 times, suggesting it can responsibly service its obligations. Looking on the bright side, Shenzhen Tianyuan DIC Information Technology boosted its EBIT by a silky 54% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Shenzhen Tianyuan DIC Information Technology saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Shenzhen Tianyuan DIC Information Technology's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. We think that Shenzhen Tianyuan DIC Information Technology's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Shenzhen Tianyuan DIC Information Technology has 3 warning signs we think you should be aware of.

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.