Fujian Star-net Communication (SZSE:002396) Seems To Use Debt Rather Sparingly

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.' 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 can see that Fujian Star-net Communication Co., LTD. (SZSE:002396) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Fujian Star-net Communication

What Is Fujian Star-net Communication's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Fujian Star-net Communication had debt of CN¥1.62b, up from CN¥840.7m in one year. However, its balance sheet shows it holds CN¥3.05b in cash, so it actually has CN¥1.43b net cash.

A Look At Fujian Star-net Communication's Liabilities

We can see from the most recent balance sheet that Fujian Star-net Communication had liabilities of CN¥6.55b falling due within a year, and liabilities of CN¥273.5m due beyond that. On the other hand, it had cash of CN¥3.05b and CN¥3.37b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥408.8m.

Since publicly traded Fujian Star-net Communication shares are worth a total of CN¥11.7b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Fujian Star-net Communication also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Fujian Star-net Communication grew its EBIT by 186% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Fujian Star-net Communication can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Fujian Star-net Communication has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Fujian Star-net Communication's free cash flow amounted to 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about Fujian Star-net Communication's liabilities, but we can be reassured by the fact it has has net cash of CN¥1.43b. And we liked the look of last year's 186% year-on-year EBIT growth. So we don't think Fujian Star-net Communication's use of debt is risky. 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 Fujian Star-net Communication is showing 2 warning signs in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.