Warren Buffett famously said, '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. As with many other companies Anhui Huilong Agricultural Means of Production Co.,Ltd. (SZSE:002556) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside 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 we examine debt levels, we first consider both cash and debt levels, together.

What Is Anhui Huilong Agricultural Means of ProductionLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Anhui Huilong Agricultural Means of ProductionLtd had debt of CN¥3.36b, up from CN¥3.11b in one year. However, it does have CN¥1.10b in cash offsetting this, leading to net debt of about CN¥2.26b.

How Healthy Is Anhui Huilong Agricultural Means of ProductionLtd's Balance Sheet?

According to the last reported balance sheet, Anhui Huilong Agricultural Means of ProductionLtd had liabilities of CN¥5.00b due within 12 months, and liabilities of CN¥2.28b due beyond 12 months. On the other hand, it had cash of CN¥1.10b and CN¥1.34b worth of receivables due within a year. So it has liabilities totalling CN¥4.85b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥5.28b, so it does suggest shareholders should keep an eye on Anhui Huilong Agricultural Means of ProductionLtd'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). 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).

Strangely Anhui Huilong Agricultural Means of ProductionLtd has a sky high EBITDA ratio of 6.1, implying high debt, but a strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Anhui Huilong Agricultural Means of ProductionLtd grew its EBIT by 6.1% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Anhui Huilong Agricultural Means of ProductionLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Anhui Huilong Agricultural Means of ProductionLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Anhui Huilong Agricultural Means of ProductionLtd's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that Anhui Huilong Agricultural Means of ProductionLtd's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. We've identified 4 warning signs with Anhui Huilong Agricultural Means of ProductionLtd , and understanding them should be part of your investment process.

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.