Shenzhen Mason TechnologiesLtd (SZSE:002654) Takes On Some Risk With Its Use Of Debt

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 Mason Technologies Co.,Ltd (SZSE:002654) does have debt on its balance sheet. 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. 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.

Check out our latest analysis for Shenzhen Mason TechnologiesLtd

How Much Debt Does Shenzhen Mason TechnologiesLtd Carry?

As you can see below, Shenzhen Mason TechnologiesLtd had CN¥774.8m of debt at September 2024, down from CN¥876.0m a year prior. However, because it has a cash reserve of CN¥265.5m, its net debt is less, at about CN¥509.3m.

A Look At Shenzhen Mason TechnologiesLtd's Liabilities

According to the last reported balance sheet, Shenzhen Mason TechnologiesLtd had liabilities of CN¥2.14b due within 12 months, and liabilities of CN¥562.6m due beyond 12 months. Offsetting these obligations, it had cash of CN¥265.5m as well as receivables valued at CN¥1.88b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥555.5m.

Of course, Shenzhen Mason TechnologiesLtd has a market capitalization of CN¥11.9b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While we wouldn't worry about Shenzhen Mason TechnologiesLtd's net debt to EBITDA ratio of 3.7, we think its super-low interest cover of 1.0 times is a sign of high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. One redeeming factor for Shenzhen Mason TechnologiesLtd is that it turned last year's EBIT loss into a gain of CN¥54m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Shenzhen Mason TechnologiesLtd'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Shenzhen Mason TechnologiesLtd 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

To be frank both Shenzhen Mason TechnologiesLtd's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. Once we consider all the factors above, together, it seems to us that Shenzhen Mason TechnologiesLtd's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. Case in point: We've spotted 2 warning signs for Shenzhen Mason TechnologiesLtd you should be aware of.

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.