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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that LianChuang Electronic Technology Co.,Ltd (SZSE:002036) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for LianChuang Electronic TechnologyLtd
What Is LianChuang Electronic TechnologyLtd's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 LianChuang Electronic TechnologyLtd had CN¥7.52b of debt, an increase on CN¥5.77b, over one year. However, because it has a cash reserve of CN¥2.79b, its net debt is less, at about CN¥4.73b.
How Strong Is LianChuang Electronic TechnologyLtd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that LianChuang Electronic TechnologyLtd had liabilities of CN¥9.05b due within 12 months and liabilities of CN¥3.35b due beyond that. On the other hand, it had cash of CN¥2.79b and CN¥3.56b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.05b.
This deficit isn't so bad because LianChuang Electronic TechnologyLtd is worth CN¥11.7b, 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. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine LianChuang Electronic TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year LianChuang Electronic TechnologyLtd had a loss before interest and tax, and actually shrunk its revenue by 11%, to CN¥10b. We would much prefer see growth.
Caveat Emptor
Not only did LianChuang Electronic TechnologyLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥329m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥999m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. Be aware that LianChuang Electronic TechnologyLtd is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...
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.
