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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Sichuan Etrol Technologies Co., Ltd. (SZSE:300370) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Sichuan Etrol Technologies Carry?
As you can see below, at the end of September 2024, Sichuan Etrol Technologies had CN¥506.8m of debt, up from CN¥437.5m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥79.5m, its net debt is less, at about CN¥427.3m.
How Strong Is Sichuan Etrol Technologies' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Sichuan Etrol Technologies had liabilities of CN¥388.1m due within 12 months and liabilities of CN¥409.5m due beyond that. Offsetting these obligations, it had cash of CN¥79.5m as well as receivables valued at CN¥293.5m due within 12 months. So it has liabilities totalling CN¥424.6m more than its cash and near-term receivables, combined.
Of course, Sichuan Etrol Technologies has a market capitalization of CN¥4.79b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sichuan Etrol Technologies will need earnings to service that debt. 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.
In the last year Sichuan Etrol Technologies'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, Sichuan Etrol Technologies had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥80m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥76m of cash over the last year. So to be blunt we think it is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Sichuan Etrol Technologies (of which 1 is a bit unpleasant!) you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
