Is Shenzhen Kaifa Technology (SZSE:000021) 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. As with many other companies Shenzhen Kaifa Technology Co., Ltd. (SZSE:000021) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shenzhen Kaifa Technology

How Much Debt Does Shenzhen Kaifa Technology Carry?

As you can see below, Shenzhen Kaifa Technology had CN¥9.76b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥9.03b in cash offsetting this, leading to net debt of about CN¥732.0m.

A Look At Shenzhen Kaifa Technology's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen Kaifa Technology had liabilities of CN¥13.2b due within 12 months and liabilities of CN¥2.37b due beyond that. On the other hand, it had cash of CN¥9.03b and CN¥3.91b worth of receivables due within a year. So it has liabilities totalling CN¥2.67b more than its cash and near-term receivables, combined.

Of course, Shenzhen Kaifa Technology has a market capitalization of CN¥29.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Shenzhen Kaifa Technology has net debt of just 0.41 times EBITDA, suggesting it could ramp leverage without breaking a sweat. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. Another good sign is that Shenzhen Kaifa Technology has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is Shenzhen Kaifa Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Shenzhen Kaifa Technology reported free cash flow worth 10% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Shenzhen Kaifa Technology's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. 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 Kaifa Technology is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. Be aware that Shenzhen Kaifa Technology is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.