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Warren Buffett once said, “Volatility is far from synonymous with risk.” So it is obvious that you need to consider debt when thinking about how risky a particular stock is, because too much debt can ruin a company. Shenzhen Sunlord Electronics Co., Ltd. (SZSE:002138) does have debt, but the more important question is: how much risk is associated with this debt?

What risks are associated with debt?

Debt helps a company until it struggles to pay it back with either fresh capital or free cash flow. In the worst case scenario, a company can go bankrupt if it can’t pay its creditors. More common (but still costly), however, is that a company must issue shares at bargain prices, permanently diluting shareholder ownership, just to shore up its balance sheet. Of course, debt can be an important tool for companies, especially capital-intensive ones. When considering how much debt a company has, you should first look at its cash and debt together.

Check out our latest analysis for Shenzhen Sunlord ElectronicsLtd

How much debt does Shenzhen Sunlord Electronics Ltd. have?

As you can see below, Shenzhen Sunlord Electronics Ltd. had debt of CN¥3.90 billion at the end of March 2024, up from CN¥3.44 billion a year ago. Click on the image for more details. However, since the company has a cash reserve of CN¥578.9 million, its net debt is lower at about CN¥3.32 billion.

How strong is the balance sheet of Shenzhen Sunlord Electronics Ltd.?

According to the last reported balance sheet, Shenzhen Sunlord Electronics Ltd. had CNY2.97 billion in liabilities with a maturity of 12 months and CNY3.05 billion in accounts payable with a maturity of more than 12 months. On the other hand, the company had CNY578.9 million in cash and CNY2.73 billion in accounts receivable with a maturity of one year. Thus, its total liabilities are CNY2.71 billion more than the sum of its cash and short-term receivables.

Given Shenzhen Sunlord Electronics Ltd.’s market capitalization of CN¥21.6 billion, it’s hard to imagine these liabilities posing much of a threat. However, there are enough liabilities that we would certainly recommend shareholders keep an eye on the balance sheet going forward.

We measure a company’s debt load relative to its earnings power by dividing its net debt by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest expenses (interest cover). So we look at debt relative to earnings both with and without depreciation and amortization expenses.

We’d say Shenzhen Sunlord Electronics Ltd.’s moderate net debt to EBITDA ratio (2.2) indicates prudence around debt. And its strong interest coverage of 10.7 times gives us even more reassurance. Notably, Shenzhen Sunlord Electronics Ltd.’s EBIT was higher than Elon Musk’s, growing a whopping 102% year over year. The balance sheet is clearly the area to focus on when analyzing debt. But it’s future earnings more than anything that will determine Shenzhen Sunlord Electronics Ltd.’s ability to maintain a healthy balance sheet going forward. So if you want to know what the professionals think, you might find this free report on analyst earnings forecasts interesting.

And finally, while the tax authorities love retained earnings, lenders only accept cash. So it’s worth checking how much of that EBIT is covered by free cash flow. Looking at the last three years, Shenzhen Sunlord Electronics Ltd. actually saw a cash outflow overall. Debt is usually more expensive and is almost always riskier in the hands of a company with negative free cash flow. Shareholders should hope for an improvement.

Our view

Shenzhen Sunlord Electronics Ltd.’s EBIT growth rate was a real plus in this analysis, as was its interest coverage. But to be honest, its conversion of EBIT to free cash flow had us biting our nails. Considering these data points, we believe Shenzhen Sunlord Electronics Ltd. is in a good position to manage its debt. But a word of caution: we believe its debt is high enough to warrant ongoing monitoring. When analyzing debt, the balance sheet is the obvious place to start. However, not all investment risks are contained in the balance sheet – quite the opposite. For example, we found that 2 warning signs for Shenzhen Sunlord ElectronicsLtd that you should know before investing here.

If, after all that, you’re more interested in a fast-growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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