We Think Inspur Electronic Information Industry (SZSE:000977) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Inspur Electronic Information Industry Co., Ltd. (SZSE:000977) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Inspur Electronic Information Industry

What Is Inspur Electronic Information Industry's Debt?

As you can see below, at the end of September 2024, Inspur Electronic Information Industry had CN¥22.8b of debt, up from CN¥17.7b a year ago. Click the image for more detail. However, it does have CN¥10.4b in cash offsetting this, leading to net debt of about CN¥12.4b.

How Healthy Is Inspur Electronic Information Industry's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Inspur Electronic Information Industry had liabilities of CN¥57.1b due within 12 months and liabilities of CN¥7.97b due beyond that. Offsetting these obligations, it had cash of CN¥10.4b as well as receivables valued at CN¥24.2b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥30.4b.

While this might seem like a lot, it is not so bad since Inspur Electronic Information Industry has a huge market capitalization of CN¥78.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

Strangely Inspur Electronic Information Industry has a sky high EBITDA ratio of 5.9, implying high debt, but a strong interest coverage of 35.2. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Notably, Inspur Electronic Information Industry's EBIT launched higher than Elon Musk, gaining a whopping 760% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Inspur Electronic Information Industry'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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Inspur Electronic Information Industry burned a lot of cash. 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

While Inspur Electronic Information Industry's conversion of EBIT to free cash flow has us nervous. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that Inspur Electronic Information Industry is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Inspur Electronic Information Industry you should be aware of.

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.