These 4 Measures Indicate That Fiberhome Telecommunication Technologies (SHSE:600498) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Fiberhome Telecommunication Technologies Co., Ltd. (SHSE:600498) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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.

View our latest analysis for Fiberhome Telecommunication Technologies

How Much Debt Does Fiberhome Telecommunication Technologies Carry?

You can click the graphic below for the historical numbers, but it shows that Fiberhome Telecommunication Technologies had CN¥7.54b of debt in March 2024, down from CN¥7.93b, one year before. However, because it has a cash reserve of CN¥3.60b, its net debt is less, at about CN¥3.93b.

How Healthy Is Fiberhome Telecommunication Technologies' Balance Sheet?

We can see from the most recent balance sheet that Fiberhome Telecommunication Technologies had liabilities of CN¥21.7b falling due within a year, and liabilities of CN¥4.30b due beyond that. Offsetting these obligations, it had cash of CN¥3.60b as well as receivables valued at CN¥14.0b due within 12 months. So it has liabilities totalling CN¥8.40b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Fiberhome Telecommunication Technologies has a market capitalization of CN¥21.0b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Fiberhome Telecommunication Technologies's net debt to EBITDA ratio of about 2.2 suggests only moderate use of debt. And its commanding EBIT of 41.5 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, Fiberhome Telecommunication Technologies grew its EBIT by 61% over the last twelve months, and that growth will make it easier to handle its debt. 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 Fiberhome Telecommunication Technologies can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Fiberhome Telecommunication Technologies saw substantial negative free cash flow, in total. 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

Fiberhome Telecommunication Technologies's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Fiberhome Telecommunication Technologies's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 1 warning sign we've spotted with Fiberhome Telecommunication Technologies .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.