Is Shenzhen Qingyi Photomask (SHSE:688138) Using Too Much Debt?

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.' 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 Shenzhen Qingyi Photomask Limited (SHSE:688138) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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

How Much Debt Does Shenzhen Qingyi Photomask Carry?

As you can see below, at the end of March 2024, Shenzhen Qingyi Photomask had CN¥507.9m of debt, up from CN¥160.3m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥404.1m, its net debt is less, at about CN¥103.7m.

How Healthy Is Shenzhen Qingyi Photomask's Balance Sheet?

The latest balance sheet data shows that Shenzhen Qingyi Photomask had liabilities of CN¥548.3m due within a year, and liabilities of CN¥274.5m falling due after that. Offsetting these obligations, it had cash of CN¥404.1m as well as receivables valued at CN¥319.8m due within 12 months. So its liabilities total CN¥98.8m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Shenzhen Qingyi Photomask's 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¥5.87b 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). 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 0.37. And its EBIT easily covers its interest expense, being 45.6 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Shenzhen Qingyi Photomask grew its EBIT by 73% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shenzhen Qingyi Photomask's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of that EBIT is backed by 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 we must concede we find its conversion of EBIT to free cash flow has the opposite effect. When we consider the range of factors above, it looks like Shenzhen Qingyi Photomask is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Shenzhen Qingyi Photomask 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.