Is Nanjing Sunlord Electronics (SZSE:300975) Using Too Much 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 can see that Nanjing Sunlord Electronics Corporation Ltd. (SZSE:300975) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Nanjing Sunlord Electronics

What Is Nanjing Sunlord Electronics's Debt?

The image below, which you can click on for greater detail, shows that Nanjing Sunlord Electronics had debt of CN¥1.19b at the end of March 2024, a reduction from CN¥1.30b over a year. However, it also had CN¥434.5m in cash, and so its net debt is CN¥753.7m.

How Strong Is Nanjing Sunlord Electronics' Balance Sheet?

The latest balance sheet data shows that Nanjing Sunlord Electronics had liabilities of CN¥1.91b due within a year, and liabilities of CN¥215.4m falling due after that. On the other hand, it had cash of CN¥434.5m and CN¥1.96b worth of receivables due within a year. So it can boast CN¥265.0m more liquid assets than total liabilities.

This surplus suggests that Nanjing Sunlord Electronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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.

Nanjing Sunlord Electronics has a rather high debt to EBITDA ratio of 6.5 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 3.5 times, suggesting it can responsibly service its obligations. Even worse, Nanjing Sunlord Electronics saw its EBIT tank 33% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Nanjing Sunlord Electronics will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Nanjing Sunlord Electronics 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 Nanjing Sunlord Electronics's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT 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. Overall, we think it's fair to say that Nanjing Sunlord Electronics has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Nanjing Sunlord Electronics is showing 5 warning signs in our investment analysis , and 2 of those make us uncomfortable...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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