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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Suntar Environmental Technology Co., Ltd. (SHSE:688101) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Suntar Environmental Technology Carry?
The chart below, which you can click on for greater detail, shows that Suntar Environmental Technology had CN¥96.6m in debt in December 2023; about the same as the year before. However, its balance sheet shows it holds CN¥1.46b in cash, so it actually has CN¥1.36b net cash.
How Strong Is Suntar Environmental Technology's Balance Sheet?
We can see from the most recent balance sheet that Suntar Environmental Technology had liabilities of CN¥1.23b falling due within a year, and liabilities of CN¥443.8m due beyond that. Offsetting this, it had CN¥1.46b in cash and CN¥912.5m in receivables that were due within 12 months. So it actually has CN¥693.8m more liquid assets than total liabilities.
It's good to see that Suntar Environmental Technology has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Suntar Environmental Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Suntar Environmental Technology has boosted its EBIT by 55%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Suntar Environmental Technology's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Suntar Environmental Technology 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, Suntar Environmental Technology actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Summing Up
While it is always sensible to investigate a company's debt, in this case Suntar Environmental Technology has CN¥1.36b in net cash and a decent-looking balance sheet. And we liked the look of last year's 55% year-on-year EBIT growth. So is Suntar Environmental Technology's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with Suntar Environmental Technology , and understanding them should be part of your investment process.
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.