Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Zhejiang Huatie Emergency Equipment Science & Technology Co.,Ltd. (SHSE:603300) does carry debt. But is this debt a concern to shareholders?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Zhejiang Huatie Emergency Equipment Science & TechnologyLtd
You can click the graphic below for the historical numbers, but it shows that as of June 2024 Zhejiang Huatie Emergency Equipment Science & TechnologyLtd had CN¥2.10b of debt, an increase on CN¥1.59b, over one year. However, because it has a cash reserve of CN¥122.2m, its net debt is less, at about CN¥1.98b.
The latest balance sheet data shows that Zhejiang Huatie Emergency Equipment Science & TechnologyLtd had liabilities of CN¥5.52b due within a year, and liabilities of CN¥8.42b falling due after that. Offsetting this, it had CN¥122.2m in cash and CN¥4.21b in receivables that were due within 12 months. So its liabilities total CN¥9.60b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of CN¥9.81b, so it does suggest shareholders should keep an eye on Zhejiang Huatie Emergency Equipment Science & TechnologyLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
While Zhejiang Huatie Emergency Equipment Science & TechnologyLtd's low debt to EBITDA ratio of 1.1 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 2.5 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. One way Zhejiang Huatie Emergency Equipment Science & TechnologyLtd could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 18%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhejiang Huatie Emergency Equipment Science & TechnologyLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Zhejiang Huatie Emergency Equipment Science & TechnologyLtd recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
On our analysis Zhejiang Huatie Emergency Equipment Science & TechnologyLtd's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. In particular, interest cover gives us cold feet. When we consider all the factors mentioned above, we do feel a bit cautious about Zhejiang Huatie Emergency Equipment Science & TechnologyLtd's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Over time, share prices tend to follow earnings per share, so if you're interested in Zhejiang Huatie Emergency Equipment Science & TechnologyLtd, you may well want to click here to check an interactive graph of its earnings per share history.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.