We Think Zhen Ding Technology Holding (TWSE:4958) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Zhen Ding Technology Holding Limited (TWSE:4958) makes use of debt. But is this debt a concern to shareholders?

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 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Zhen Ding Technology Holding

What Is Zhen Ding Technology Holding's Net Debt?

As you can see below, at the end of September 2023, Zhen Ding Technology Holding had NT$51.6b of debt, up from NT$46.5b a year ago. Click the image for more detail. However, it does have NT$59.7b in cash offsetting this, leading to net cash of NT$8.07b.

How Strong Is Zhen Ding Technology Holding's Balance Sheet?

We can see from the most recent balance sheet that Zhen Ding Technology Holding had liabilities of NT$83.3b falling due within a year, and liabilities of NT$30.0b due beyond that. Offsetting this, it had NT$59.7b in cash and NT$33.8b in receivables that were due within 12 months. So its liabilities total NT$19.8b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Zhen Ding Technology Holding is worth NT$95.9b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Zhen Ding Technology Holding boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Zhen Ding Technology Holding's load is not too heavy, because its EBIT was down 47% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Zhen Ding Technology Holding can strengthen its balance sheet over time. 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 Zhen Ding Technology Holding 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. Considering the last three years, Zhen Ding Technology Holding actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While Zhen Ding Technology Holding does have more liabilities than liquid assets, it also has net cash of NT$8.07b. So while Zhen Ding Technology Holding does not have a great balance sheet, it's certainly not too bad. 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. Be aware that Zhen Ding Technology Holding is showing 2 warning signs in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.