Toyou Feiji Electronics (SZSE:300302) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, '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 Toyou Feiji Electronics Co., Ltd. (SZSE:300302) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Toyou Feiji Electronics

How Much Debt Does Toyou Feiji Electronics Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Toyou Feiji Electronics had debt of CN¥464.6m, up from CN¥345.3m in one year. However, it does have CN¥105.6m in cash offsetting this, leading to net debt of about CN¥359.0m.

How Healthy Is Toyou Feiji Electronics' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Toyou Feiji Electronics had liabilities of CN¥329.7m due within 12 months and liabilities of CN¥241.4m due beyond that. Offsetting this, it had CN¥105.6m in cash and CN¥411.4m in receivables that were due within 12 months. So it has liabilities totalling CN¥54.1m more than its cash and near-term receivables, combined.

This state of affairs indicates that Toyou Feiji Electronics' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥7.31b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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

As it happens Toyou Feiji Electronics has a fairly concerning net debt to EBITDA ratio of 6.5 but very strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! We also note that Toyou Feiji Electronics improved its EBIT from a last year's loss to a positive CN¥39m. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Toyou Feiji Electronics will need earnings to service that debt. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Toyou Feiji Electronics 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

Neither Toyou Feiji Electronics's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. We think that Toyou Feiji Electronics'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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Toyou Feiji Electronics .

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.