Shenzhen Sunlord ElectronicsLtd (SZSE:002138) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We note that Shenzhen Sunlord Electronics Co.,Ltd. (SZSE:002138) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shenzhen Sunlord ElectronicsLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Shenzhen Sunlord ElectronicsLtd had debt of CN¥3.27b at the end of December 2024, a reduction from CN¥3.74b over a year. However, because it has a cash reserve of CN¥302.3m, its net debt is less, at about CN¥2.97b.

How Healthy Is Shenzhen Sunlord ElectronicsLtd's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Sunlord ElectronicsLtd had liabilities of CN¥3.21b falling due within a year, and liabilities of CN¥2.54b due beyond that. Offsetting these obligations, it had cash of CN¥302.3m as well as receivables valued at CN¥3.07b due within 12 months. So its liabilities total CN¥2.38b more than the combination of its cash and short-term receivables.

Given Shenzhen Sunlord ElectronicsLtd has a market capitalization of CN¥23.7b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

Check out our latest analysis for Shenzhen Sunlord ElectronicsLtd

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

We'd say that Shenzhen Sunlord ElectronicsLtd's moderate net debt to EBITDA ratio ( being 1.7), indicates prudence when it comes to debt. And its commanding EBIT of 12.2 times its interest expense, implies the debt load is as light as a peacock feather. It is well worth noting that Shenzhen Sunlord ElectronicsLtd's EBIT shot up like bamboo after rain, gaining 32% in the last twelve months. That'll make it easier to manage its debt. 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 Sunlord ElectronicsLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Shenzhen Sunlord ElectronicsLtd created free cash flow amounting to 14% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Shenzhen Sunlord ElectronicsLtd'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, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that Shenzhen Sunlord ElectronicsLtd takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Shenzhen Sunlord ElectronicsLtd .

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.