Is EST Tools (SZSE:300488) Using Too Much Debt?

Warren Buffett famously said, “Volatility is far from synonymous with risk.” When we think about how risky a company is, we always look at its use of debt, because over-leverage can lead to ruin. We take note of that EST Tools Co., Ltd (SZSE:300488) has debt on its balance sheet. But the real question is whether this debt makes the company risky.

What risk does debt bring with it?

Debt and other liabilities become risky for a company when it cannot easily meet those obligations, either through free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While this isn’t all that common, we often see indebted companies permanently diluting their shareholders because lenders force them to raise capital at a distressed price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When considering how much debt a company has, you first need to consider its cash flow and debt together.

Check out our latest analysis for EST Tools

How much debt does EST Tools have?

You can click on the graphic below to see the historical numbers. However, it shows that EST Tools had debt of CN¥571.6 million as of September 2024, an increase from CN¥27.0 million in a year. However, since the company has a cash reserve of CN¥447.0 million, its net debt is lower, at about CN¥124.6 million.

A look at EST Tools’ liabilities

According to the last reported balance sheet, EST Tools had liabilities of C¥172.5m due within 12 months, and liabilities of C¥586.9m due beyond 12 months. Offsetting this, it had CN¥447.0m in cash and CN¥305.6m in receivables that were due within 12 months. These liquid assets roughly correspond to the total liabilities.

This state of affairs suggests that EST Tools’ balance sheet looks quite solid, with total liabilities roughly equal to its liquid assets. So it’s very unlikely that the CN¥4.36b company is strapped for cash, but it’s still worth keeping an eye on the balance sheet.

We measure a company’s debt load relative to its earnings power by dividing its net debt by its earnings before interest, tax, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and tax (EBIT) can cover its interest expense (interest cover). ). We take into account both the absolute amount of the debt and the interest paid on it.

EST Tools’ net debt is just 0.51 times its EBITDA. And its EBIT easily covers its interest expense and is 18.9x. So we’re pretty relaxed when it comes to dealing with debt in an extremely conservative manner. Additionally, we’re pleased to report that EST Tools grew its EBIT by 31%, reducing the threat of future debt repayments. There is no doubt that the balance sheet is where we learn the most about debt. But you can’t look at debt in complete isolation; as EST Tools will need revenue to service this debt. So if you’re interested in discovering more about the company’s earnings, it might be worth checking out this graph of its long-term earnings trend.

After all, a company needs free cash flow to pay off debt. Book profits are simply not enough. So it’s worth checking how much of that EBIT is covered by free cash flow. Over the last three years, EST Tools generated stable free cash flow equal to 68% of its EBIT, which is about in line with our expectations. This free cash flow puts the company in a good position to pay down debt if necessary.

Our view

Encouragingly, EST Tools’ impressive interest coverage suggests that the company has the upper hand on its debt. And that’s just the beginning of the good news, as the EBIT growth rate is also very encouraging. Overall, we don’t see EST Tools taking big risks, as its debt load appears modest. So we’re not worried about using a little leverage on the balance sheet. The balance sheet is clearly the area you should focus on when analyzing debt. However, not all investment risks lie on the balance sheet – quite the opposite. We’ve identified 1 warning sign using EST tools and understanding them should be part of your investment process.

Ultimately, it’s often better to focus on companies that are free of net debt. You can access our special list of such companies (all with a track record of growing profits). It’s free.

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This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended as financial advice. It does not constitute 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 focused analysis based on fundamental data. Note that our analysis may not reflect the latest price-sensitive company announcements or qualitative material. Simply Wall St has no positions in any stocks mentioned.