Here's Why Nanjing Sample Technology (HKG:1708) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, Nanjing Sample Technology Company Limited (HKG:1708) does carry debt. But the more important question is: how much risk is that debt creating?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Nanjing Sample Technology

What Is Nanjing Sample Technology's Net Debt?

The image below, which you can click on for greater detail, shows that Nanjing Sample Technology had debt of CN¥685.7m at the end of December 2023, a reduction from CN¥823.1m over a year. On the flip side, it has CN¥383.8m in cash leading to net debt of about CN¥302.0m.

A Look At Nanjing Sample Technology's Liabilities

The latest balance sheet data shows that Nanjing Sample Technology had liabilities of CN¥1.13b due within a year, and liabilities of CN¥114.9m falling due after that. Offsetting this, it had CN¥383.8m in cash and CN¥1.64b in receivables that were due within 12 months. So it can boast CN¥779.4m more liquid assets than total liabilities.

This luscious liquidity implies that Nanjing Sample Technology's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.39 times and a disturbingly high net debt to EBITDA ratio of 6.1 hit our confidence in Nanjing Sample Technology like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Nanjing Sample Technology is that it turned last year's EBIT loss into a gain of CN¥13m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Nanjing Sample Technology's earnings that will influence how the balance sheet holds up in the future. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Nanjing Sample Technology actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that Nanjing Sample Technology's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But we must concede we find its interest cover has the opposite effect. When we consider the range of factors above, it looks like Nanjing Sample Technology is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Nanjing Sample Technology (at least 2 which are concerning) , and understanding them should be part of your investment process.

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.