These 4 Measures Indicate That Shenzhen Microgate Technology (SZSE:300319) Is Using Debt Safely

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Shenzhen Microgate Technology Co., Ltd. (SZSE:300319) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. 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 Shenzhen Microgate Technology

What Is Shenzhen Microgate Technology's Debt?

As you can see below, at the end of March 2024, Shenzhen Microgate Technology had CN¥85.0m of debt, up from CN¥53.3m a year ago. Click the image for more detail. But it also has CN¥1.15b in cash to offset that, meaning it has CN¥1.06b net cash.

A Look At Shenzhen Microgate Technology's Liabilities

According to the last reported balance sheet, Shenzhen Microgate Technology had liabilities of CN¥1.53b due within 12 months, and liabilities of CN¥257.3m due beyond 12 months. On the other hand, it had cash of CN¥1.15b and CN¥1.15b worth of receivables due within a year. So it actually has CN¥509.1m more liquid assets than total liabilities.

This surplus suggests that Shenzhen Microgate Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shenzhen Microgate Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Shenzhen Microgate Technology grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle 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 Microgate Technology 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. Shenzhen Microgate Technology may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Shenzhen Microgate Technology recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Microgate Technology has net cash of CN¥1.06b, as well as more liquid assets than liabilities. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in CN¥253m. So is Shenzhen Microgate Technology's debt a risk? It doesn't seem so to us. 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. Be aware that Shenzhen Microgate Technology is showing 1 warning sign 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.

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