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.' 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. Importantly, Shanghai Taisheng Wind Power Equipment Co., Ltd. (SZSE:300129) does carry debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Shanghai Taisheng Wind Power Equipment's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shanghai Taisheng Wind Power Equipment had CN¥833.7m of debt, an increase on CN¥223.1m, over one year. However, it does have CN¥609.3m in cash offsetting this, leading to net debt of about CN¥224.3m.

A Look At Shanghai Taisheng Wind Power Equipment's Liabilities

We can see from the most recent balance sheet that Shanghai Taisheng Wind Power Equipment had liabilities of CN¥3.19b falling due within a year, and liabilities of CN¥514.4m due beyond that. On the other hand, it had cash of CN¥609.3m and CN¥3.30b worth of receivables due within a year. So it actually has CN¥203.6m more liquid assets than total liabilities.

This surplus suggests that Shanghai Taisheng Wind Power Equipment has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shanghai Taisheng Wind Power Equipment has a low net debt to EBITDA ratio of only 0.56. And its EBIT covers its interest expense a whopping 74.5 times over. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that Shanghai Taisheng Wind Power Equipment has been able to increase its EBIT by 23% in twelve months, making it easier to pay down 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 Shanghai Taisheng Wind Power Equipment'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Shanghai Taisheng Wind Power Equipment burned a lot of cash. 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.

Our View

Happily, Shanghai Taisheng Wind Power Equipment's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Shanghai Taisheng Wind Power Equipment can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Shanghai Taisheng Wind Power Equipment is showing 3 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.