The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Jiangsu Leadmicro Nano-Equipment Technology Ltd (SHSE:688147) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Jiangsu Leadmicro Nano-Equipment Technology's Net Debt?
As you can see below, at the end of March 2024, Jiangsu Leadmicro Nano-Equipment Technology had CN¥1.04b of debt, up from CN¥268.9m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.21b in cash, so it actually has CN¥170.2m net cash.
How Healthy Is Jiangsu Leadmicro Nano-Equipment Technology's Balance Sheet?
We can see from the most recent balance sheet that Jiangsu Leadmicro Nano-Equipment Technology had liabilities of CN¥5.88b falling due within a year, and liabilities of CN¥268.6m due beyond that. Offsetting this, it had CN¥1.21b in cash and CN¥888.4m in receivables that were due within 12 months. So its liabilities total CN¥4.05b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Jiangsu Leadmicro Nano-Equipment Technology has a market capitalization of CN¥13.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Jiangsu Leadmicro Nano-Equipment Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.
Even more impressive was the fact that Jiangsu Leadmicro Nano-Equipment Technology grew its EBIT by 2,810% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Jiangsu Leadmicro Nano-Equipment Technology 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Jiangsu Leadmicro Nano-Equipment 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. Over the last three years, Jiangsu Leadmicro Nano-Equipment Technology saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing Up
While Jiangsu Leadmicro Nano-Equipment Technology does have more liabilities than liquid assets, it also has net cash of CN¥170.2m. And we liked the look of last year's 2,810% year-on-year EBIT growth. So we are not troubled with Jiangsu Leadmicro Nano-Equipment Technology's debt use. 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 example - Jiangsu Leadmicro Nano-Equipment Technology has 1 warning sign we think you should be aware of.
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.