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. Importantly, Zhejiang Tony Electronic Co., Ltd (SHSE:603595) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Zhejiang Tony Electronic's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Zhejiang Tony Electronic had debt of CN¥2.34b, up from CN¥1.62b in one year. However, it does have CN¥375.2m in cash offsetting this, leading to net debt of about CN¥1.96b.
How Healthy Is Zhejiang Tony Electronic's Balance Sheet?
According to the last reported balance sheet, Zhejiang Tony Electronic had liabilities of CN¥2.17b due within 12 months, and liabilities of CN¥1.21b due beyond 12 months. On the other hand, it had cash of CN¥375.2m and CN¥902.2m worth of receivables due within a year. So it has liabilities totalling CN¥2.11b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Zhejiang Tony Electronic is worth CN¥4.46b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. 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 Zhejiang Tony Electronic's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Zhejiang Tony Electronic's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.
Caveat Emptor
Importantly, Zhejiang Tony Electronic had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥65m at the EBIT level. 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¥1.3b in negative free cash flow over the last twelve months. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Zhejiang Tony Electronic (of which 1 doesn't sit too well with us!) you should know about.
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.