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. Importantly, Shenzhen Transsion Holdings Co., Ltd. (SHSE:688036) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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.
What Is Shenzhen Transsion Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Shenzhen Transsion Holdings had debt of CN¥2.68b, up from CN¥2.49b in one year. However, it does have CN¥26.4b in cash offsetting this, leading to net cash of CN¥23.7b.
How Strong Is Shenzhen Transsion Holdings' Balance Sheet?
The latest balance sheet data shows that Shenzhen Transsion Holdings had liabilities of CN¥23.7b due within a year, and liabilities of CN¥4.21b falling due after that. Offsetting this, it had CN¥26.4b in cash and CN¥2.70b in receivables that were due within 12 months. So it actually has CN¥1.14b more liquid assets than total liabilities.
Having regard to Shenzhen Transsion Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥105.7b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Shenzhen Transsion Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, Shenzhen Transsion Holdings grew its EBIT by 243% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Shenzhen Transsion Holdings 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shenzhen Transsion Holdings 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. Happily for any shareholders, Shenzhen Transsion Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Transsion Holdings has net cash of CN¥23.7b, as well as more liquid assets than liabilities. The cherry on top was that in converted 111% of that EBIT to free cash flow, bringing in CN¥8.9b. So we don't think Shenzhen Transsion Holdings's use of debt is 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Shenzhen Transsion Holdings you should know about.
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.