We Think Shanghai Fudan Microelectronics Group (HKG:1385) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Shanghai Fudan Microelectronics Group Company Limited (HKG:1385) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for Shanghai Fudan Microelectronics Group

What Is Shanghai Fudan Microelectronics Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Shanghai Fudan Microelectronics Group had CN¥397.4m of debt, an increase on CN¥87.2m, over one year. However, it does have CN¥819.9m in cash offsetting this, leading to net cash of CN¥422.5m.

How Healthy Is Shanghai Fudan Microelectronics Group's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Fudan Microelectronics Group had liabilities of CN¥1.51b falling due within a year, and liabilities of CN¥69.6m due beyond that. On the other hand, it had cash of CN¥819.9m and CN¥1.32b worth of receivables due within a year. So it can boast CN¥558.9m more liquid assets than total liabilities.

This state of affairs indicates that Shanghai Fudan Microelectronics Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥35.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Shanghai Fudan Microelectronics Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Shanghai Fudan Microelectronics Group has boosted its EBIT by 57%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shanghai Fudan Microelectronics Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Shanghai Fudan Microelectronics Group 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, Shanghai Fudan Microelectronics Group 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 Shanghai Fudan Microelectronics Group has CN¥422.5m in net cash and a decent-looking balance sheet. And we liked the look of last year's 57% year-on-year EBIT growth. So we are not troubled with Shanghai Fudan Microelectronics Group's debt use. 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 Shanghai Fudan Microelectronics Group is showing 1 warning sign in our investment analysis , you should know about...

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.