Here's Why Shenzhen Qingyi Photomask (SHSE:688138) Can Manage Its Debt Responsibly

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. We can see that Shenzhen Qingyi Photomask Limited (SHSE:688138) does use debt in its business. 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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shenzhen Qingyi Photomask

How Much Debt Does Shenzhen Qingyi Photomask Carry?

As you can see below, at the end of September 2024, Shenzhen Qingyi Photomask had CN¥668.8m of debt, up from CN¥206.0m a year ago. Click the image for more detail. On the flip side, it has CN¥476.6m in cash leading to net debt of about CN¥192.3m.

How Healthy Is Shenzhen Qingyi Photomask's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen Qingyi Photomask had liabilities of CN¥778.1m due within 12 months and liabilities of CN¥386.4m due beyond that. Offsetting this, it had CN¥476.6m in cash and CN¥350.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥337.4m.

Since publicly traded Shenzhen Qingyi Photomask shares are worth a total of CN¥6.39b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Shenzhen Qingyi Photomask has a low net debt to EBITDA ratio of only 0.65. And its EBIT easily covers its interest expense, being 15.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Shenzhen Qingyi Photomask has boosted its EBIT by 47%, thus reducing the spectre of future debt repayments. 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 Qingyi Photomask 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Shenzhen Qingyi Photomask 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

The good news is that Shenzhen Qingyi Photomask's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Shenzhen Qingyi Photomask can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Shenzhen Qingyi Photomask (of which 1 makes us a bit uncomfortable!) you should know about.

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.