Shenzhen Deren Electronic (SZSE:002055) Is Making Moderate Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Shenzhen Deren Electronic Co., Ltd. (SZSE:002055) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shenzhen Deren Electronic

How Much Debt Does Shenzhen Deren Electronic Carry?

You can click the graphic below for the historical numbers, but it shows that Shenzhen Deren Electronic had CN¥566.7m of debt in September 2024, down from CN¥990.6m, one year before. On the flip side, it has CN¥209.4m in cash leading to net debt of about CN¥357.3m.

How Strong Is Shenzhen Deren Electronic's Balance Sheet?

According to the last reported balance sheet, Shenzhen Deren Electronic had liabilities of CN¥3.33b due within 12 months, and liabilities of CN¥1.96b due beyond 12 months. On the other hand, it had cash of CN¥209.4m and CN¥2.16b worth of receivables due within a year. So it has liabilities totalling CN¥2.92b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥3.73b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shenzhen Deren Electronic'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.

In the last year Shenzhen Deren Electronic had a loss before interest and tax, and actually shrunk its revenue by 33%, to CN¥4.8b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Shenzhen Deren Electronic's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥299m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥435m of cash over the last year. So suffice it to say we consider the stock very risky. 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. For instance, we've identified 3 warning signs for Shenzhen Deren Electronic that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.