Is Beijing Chieftain Control Engineering Technology (SZSE:300430) a risky investment?

Li Lu, an external fund manager backed by Berkshire Hathaway's Charlie Munger, has stated clearly that “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 look at its use of debt, because too much debt can lead to ruin. Beijing Chieftain Control Engineering Technology Co., Ltd. ( SZSE:300430 ) does have debt on its balance sheet, but the real question is whether this debt is making the company risky.

When does debt become dangerous?

Debt helps a company until it has trouble paying it off, with either new capital or free cash flow. If things go wrong, lenders may take control of the company. However, a more common (but still painful) scenario is that a company is forced to raise new equity capital at a low price, permanently diluting shareholder wealth. That said, the most common situation is when a company is managing its debt reasonably well, and in its favor. When thinking about a company's use of debt, we first look at cash and debt together.

Read our latest analysis on Beijing Chieftain Control Engineering Technology

What is Beijing Chieftain Control Engineering Technology's debt?

Click on the chart below for the historical numbers: As of March 2024, Beijing Chieftain Control Engineering Technology had debt of RMB630m, up from RMB516.7m a year earlier. Meanwhile, it has RMB178m in cash, leading to net debt of about RMB452m.

How strong is Beijing Chieftain Control Engineering Technology's balance sheet?

Zooming in on the latest balance sheet data, we can see that Beijing Chieftain Control Engineering Technology had liabilities of yuan1.05b due within 12 months, and liabilities of yuan204.2m due beyond that. Offsetting these debts, it has cash of yuan178m and receivables of yuan1.03b due within 12 months. Thus, its total liabilities are yuan44.5m more than the combination of its cash and short-term receivables.

Considering Beijing Chieftain Control Engineering Technology's size, its current assets seem well balanced with its total liabilities, so while it's unlikely the CNY4.41b company is struggling for cash, we still think it's worth keeping an eye on its balance sheet.

We use two main ratios to look at debt levels relative to earnings: the first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), and the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or interest cover ratio for short).The advantage of this approach is that it takes into account both the absolute quantum of debt (net debt to EBITDA) and the actual interest expense associated with that debt (interest cover ratio).

Beijing Chieftain Control Engineering Technology's net debt to EBITDA ratio is around 2.0, suggesting that it has moderate use of debt. Also, its high interest cover of 10.5x gives further reassurance. Importantly, Beijing Chieftain Control Engineering Technology grew its EBIT by 34% over the last twelve months, which should make it easier to handle its debt. The balance sheet is the focus when analysing debt. However, whether Beijing Chieftain Control Engineering Technology can maintain a healthy balance sheet going forward will depend more on future earnings than anything else. So if you want to see what the experts think, you might find this free report on analyst profit forecasts to be interesting.

Finally, businesses need free cash flow to pay down debt – accounting profits alone aren't enough, so the logical step is to look at the ratio of EBIT to actual free cash flow. Over the last three years Beijing Chieftain Control Engineering Technology has had significantly negative free cash flow in total. This could be the result of spending for growth, but it does make the debt much more risky.

Our take

The good news is that Beijing Chieftain Control Engineering Technology has demonstrated the ability to grow EBIT, which makes us happy like a fluffy puppy makes a toddler happy. But the harsh reality is that the conversion of EBIT to free cash flow is a concern. Taking all this into account, Beijing Chieftain Control Engineering Technology appears to be able to handle its current debt levels without any issues. Of course, this leverage can increase return on equity, but it also increases risk, so we should be careful here. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, all companies can have risks that exist outside the balance sheet. We've identified 1 warning sign We have partnered with Beijing Chieftain Control Engineering Technology, and understanding them should be part of your investment process.

After all, sometimes it's easier to focus on companies that don't need debt, and readers can access our list of growth stocks with zero net debt. 100% Freeright now.

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This article by Simply Wall St is general in nature. We use only unbiased methodologies to provide commentary based on historical data and analyst forecasts, and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks, and does not take into account your objectives, or your financial situation. We seek to provide long-term focused analysis driven by fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.