Is Suzhou Dongshan Precision Manufacturing (SZSE:002384) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Suzhou Dongshan Precision Manufacturing Co., Ltd. (SZSE:002384) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Suzhou Dongshan Precision Manufacturing

What Is Suzhou Dongshan Precision Manufacturing's Net Debt?

As you can see below, Suzhou Dongshan Precision Manufacturing had CN¥11.9b of debt at September 2024, down from CN¥14.1b a year prior. On the flip side, it has CN¥6.46b in cash leading to net debt of about CN¥5.45b.

How Healthy Is Suzhou Dongshan Precision Manufacturing's Balance Sheet?

We can see from the most recent balance sheet that Suzhou Dongshan Precision Manufacturing had liabilities of CN¥18.3b falling due within a year, and liabilities of CN¥8.53b due beyond that. On the other hand, it had cash of CN¥6.46b and CN¥8.06b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥12.3b.

This deficit isn't so bad because Suzhou Dongshan Precision Manufacturing is worth CN¥50.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Suzhou Dongshan Precision Manufacturing has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 12.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Suzhou Dongshan Precision Manufacturing grew its EBIT by 8.7% in the last year, making that debt load look even more manageable. 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 Suzhou Dongshan Precision Manufacturing'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Suzhou Dongshan Precision Manufacturing recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Suzhou Dongshan Precision Manufacturing's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And its net debt to EBITDA is good too. Looking at all the aforementioned factors together, it strikes us that Suzhou Dongshan Precision Manufacturing can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Suzhou Dongshan Precision Manufacturing you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.