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.' 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, Shenyang Machine Tool Co., Ltd. (SZSE:000410) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
What Is Shenyang Machine Tool's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shenyang Machine Tool had CN¥1.10b of debt, an increase on none, over one year. On the flip side, it has CN¥280.7m in cash leading to net debt of about CN¥817.1m.
A Look At Shenyang Machine Tool's Liabilities
We can see from the most recent balance sheet that Shenyang Machine Tool had liabilities of CN¥1.55b falling due within a year, and liabilities of CN¥613.7m due beyond that. Offsetting these obligations, it had cash of CN¥280.7m as well as receivables valued at CN¥722.7m due within 12 months. So its liabilities total CN¥1.16b more than the combination of its cash and short-term receivables.
Given Shenyang Machine Tool has a market capitalization of CN¥14.5b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shenyang Machine Tool 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.
Over 12 months, Shenyang Machine Tool made a loss at the EBIT level, and saw its revenue drop to CN¥1.5b, which is a fall of 5.8%. We would much prefer see growth.
Caveat Emptor
Importantly, Shenyang Machine Tool had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥225m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of CN¥44m and the profit of CN¥29m. So one might argue that there's still a chance it can get things on the right track. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Shenyang Machine Tool (1 makes us a bit uncomfortable) you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
