These 4 Measures Indicate That Shenzhen Yitoa Intelligent ControlLtd (SZSE:300131) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Shenzhen Yitoa Intelligent Control Co.,Ltd. (SZSE:300131) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shenzhen Yitoa Intelligent ControlLtd

What Is Shenzhen Yitoa Intelligent ControlLtd's Debt?

As you can see below, Shenzhen Yitoa Intelligent ControlLtd had CN¥570.6m of debt at March 2024, down from CN¥750.3m a year prior. However, because it has a cash reserve of CN¥371.8m, its net debt is less, at about CN¥198.8m.

A Look At Shenzhen Yitoa Intelligent ControlLtd's Liabilities

The latest balance sheet data shows that Shenzhen Yitoa Intelligent ControlLtd had liabilities of CN¥1.45b due within a year, and liabilities of CN¥217.4m falling due after that. On the other hand, it had cash of CN¥371.8m and CN¥1.00b worth of receivables due within a year. So its liabilities total CN¥296.6m more than the combination of its cash and short-term receivables.

Since publicly traded Shenzhen Yitoa Intelligent ControlLtd shares are worth a total of CN¥5.11b, 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.

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.

Shenzhen Yitoa Intelligent ControlLtd's net debt is sitting at a very reasonable 1.6 times its EBITDA, while its EBIT covered its interest expense just 3.0 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, Shenzhen Yitoa Intelligent ControlLtd's EBIT fell a jaw-dropping 36% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is Shenzhen Yitoa Intelligent ControlLtd'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.

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. Over the most recent three years, Shenzhen Yitoa Intelligent ControlLtd recorded free cash flow worth 73% 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

Shenzhen Yitoa Intelligent ControlLtd's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its conversion of EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about Shenzhen Yitoa Intelligent ControlLtd's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Shenzhen Yitoa Intelligent ControlLtd you should know about.

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.

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