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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Zhejiang Xinhua Chemical Co.,Ltd (SHSE:603867) does use debt in its business. But is this debt a concern to shareholders?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Zhejiang Xinhua ChemicalLtd
You can click the graphic below for the historical numbers, but it shows that as of June 2024 Zhejiang Xinhua ChemicalLtd had CN¥739.4m of debt, an increase on CN¥669.2m, over one year. However, it does have CN¥561.3m in cash offsetting this, leading to net debt of about CN¥178.1m.
We can see from the most recent balance sheet that Zhejiang Xinhua ChemicalLtd had liabilities of CN¥699.5m falling due within a year, and liabilities of CN¥866.0m due beyond that. Offsetting this, it had CN¥561.3m in cash and CN¥798.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥205.5m.
Since publicly traded Zhejiang Xinhua ChemicalLtd shares are worth a total of CN¥4.76b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Zhejiang Xinhua ChemicalLtd's net debt is only 0.39 times its EBITDA. And its EBIT easily covers its interest expense, being 25.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that Zhejiang Xinhua ChemicalLtd has increased its EBIT by 7.0% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Zhejiang Xinhua ChemicalLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Zhejiang Xinhua ChemicalLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Based on what we've seen Zhejiang Xinhua ChemicalLtd is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Zhejiang Xinhua ChemicalLtd is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Zhejiang Xinhua ChemicalLtd .
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.