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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Fiberhome Telecommunication Technologies Co., Ltd. (SHSE:600498) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Fiberhome Telecommunication Technologies

How Much Debt Does Fiberhome Telecommunication Technologies Carry?

As you can see below, Fiberhome Telecommunication Technologies had CN¥8.40b of debt at June 2024, down from CN¥8.87b a year prior. On the flip side, it has CN¥3.85b in cash leading to net debt of about CN¥4.55b.

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¥5.81b due beyond that. Offsetting this, it had CN¥3.85b in cash and CN¥17.3b in receivables that were due within 12 months. So it has liabilities totalling CN¥6.35b more than its cash and near-term receivables, combined.

Fiberhome Telecommunication Technologies has a market capitalization of CN¥19.3b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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

With net debt to EBITDA of 3.0 Fiberhome Telecommunication Technologies has a fairly noticeable amount of debt. But the high interest coverage of 7.8 suggests it can easily service that debt. Importantly, Fiberhome Telecommunication Technologies grew its EBIT by 72% 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're focused on the future you can check out this free report showing analyst profit forecasts.

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, Fiberhome Telecommunication Technologies burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Fiberhome Telecommunication Technologies is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to grow its EBIT is pretty flash. 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Fiberhome Telecommunication Technologies that 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.