Is China Electric Mfg (TWSE:1611) Using Too Much Debt?

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. We can see that China Electric Mfg. Corporation (TWSE:1611) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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.

See our latest analysis for China Electric Mfg

What Is China Electric Mfg's Net Debt?

As you can see below, China Electric Mfg had NT$600.0m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has NT$1.72b in cash to offset that, meaning it has NT$1.12b net cash.

A Look At China Electric Mfg's Liabilities

We can see from the most recent balance sheet that China Electric Mfg had liabilities of NT$882.0m falling due within a year, and liabilities of NT$184.6m due beyond that. Offsetting these obligations, it had cash of NT$1.72b as well as receivables valued at NT$195.1m due within 12 months. So it actually has NT$848.3m more liquid assets than total liabilities.

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

On the other hand, China Electric Mfg's EBIT dived 19%, over the last year. 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 you can't view debt in total isolation; since China Electric Mfg will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While China Electric Mfg 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. Happily for any shareholders, China Electric Mfg actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Electric Mfg has net cash of NT$1.12b, as well as more liquid assets than liabilities. The cherry on top was that in converted 481% of that EBIT to free cash flow, bringing in NT$365m. So is China Electric Mfg'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. Case in point: We've spotted 3 warning signs for China Electric Mfg you should be aware of, and 1 of them doesn't sit too well with us.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com