Here's Why Shenzhen Sunline Tech (SZSE:300348) Has A Meaningful Debt Burden

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Shenzhen Sunline Tech Co., Ltd. (SZSE:300348) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Shenzhen Sunline Tech

What Is Shenzhen Sunline Tech's Net Debt?

As you can see below, Shenzhen Sunline Tech had CN¥303.7m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥228.9m in cash offsetting this, leading to net debt of about CN¥74.8m.

A Look At Shenzhen Sunline Tech's Liabilities

The latest balance sheet data shows that Shenzhen Sunline Tech had liabilities of CN¥795.8m due within a year, and liabilities of CN¥71.2m falling due after that. Offsetting these obligations, it had cash of CN¥228.9m as well as receivables valued at CN¥1.16b due within 12 months. So it can boast CN¥523.2m more liquid assets than total liabilities.

This surplus suggests that Shenzhen Sunline Tech 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.

With net debt sitting at just 1.3 times EBITDA, Shenzhen Sunline Tech is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 8.4 times the interest expense over the last year. On the other hand, Shenzhen Sunline Tech's EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Shenzhen Sunline Tech can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Shenzhen Sunline Tech 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

Both Shenzhen Sunline Tech's conversion of EBIT to free cash flow and its EBIT growth rate were discouraging. But its not so bad at covering its interest expense with its EBIT. Taking the abovementioned factors together we do think Shenzhen Sunline Tech's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 Shenzhen Sunline Tech'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.