Is WCON Electronics (Guangdong) (SZSE:301328) A Risky Investment?

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. Importantly, WCON Electronics (Guangdong) Co., Ltd. (SZSE:301328) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for WCON Electronics (Guangdong)

What Is WCON Electronics (Guangdong)'s Debt?

As you can see below, WCON Electronics (Guangdong) had CN¥36.6m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥1.29b in cash offsetting this, leading to net cash of CN¥1.25b.

How Strong Is WCON Electronics (Guangdong)'s Balance Sheet?

We can see from the most recent balance sheet that WCON Electronics (Guangdong) had liabilities of CN¥86.4m falling due within a year, and liabilities of CN¥31.0m due beyond that. On the other hand, it had cash of CN¥1.29b and CN¥178.1m worth of receivables due within a year. So it can boast CN¥1.35b more liquid assets than total liabilities.

This excess liquidity is a great indication that WCON Electronics (Guangdong)'s balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that WCON Electronics (Guangdong) has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that WCON Electronics (Guangdong) has seen its EBIT plunge 19% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine WCON Electronics (Guangdong)'s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While WCON Electronics (Guangdong) 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. Over the last three years, WCON Electronics (Guangdong) saw substantial negative free cash flow, in total. 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case WCON Electronics (Guangdong) has CN¥1.25b in net cash and a decent-looking balance sheet. So we are not troubled with WCON Electronics (Guangdong)'s debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for WCON Electronics (Guangdong) you should be aware of, and 1 of them can't be ignored.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.