Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Lizhong Sitong Light Alloys Group Co., Ltd. (SZSE:300428) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with 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 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Lizhong Sitong Light Alloys Group's Net Debt?

As you can see below, at the end of March 2024, Lizhong Sitong Light Alloys Group had CN¥9.53b of debt, up from CN¥8.81b a year ago. Click the image for more detail. However, it also had CN¥2.63b in cash, and so its net debt is CN¥6.90b.

How Strong Is Lizhong Sitong Light Alloys Group's Balance Sheet?

The latest balance sheet data shows that Lizhong Sitong Light Alloys Group had liabilities of CN¥8.42b due within a year, and liabilities of CN¥3.67b falling due after that. Offsetting these obligations, it had cash of CN¥2.63b as well as receivables valued at CN¥6.23b due within 12 months. So it has liabilities totalling CN¥3.23b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Lizhong Sitong Light Alloys Group has a market capitalization of CN¥11.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Lizhong Sitong Light Alloys Group has a debt to EBITDA ratio of 4.4 and its EBIT covered its interest expense 3.6 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Looking on the bright side, Lizhong Sitong Light Alloys Group boosted its EBIT by a silky 83% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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 Lizhong Sitong Light Alloys Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Lizhong Sitong Light Alloys Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Lizhong Sitong Light Alloys Group's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. We think that Lizhong Sitong Light Alloys Group's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Lizhong Sitong Light Alloys Group is showing 1 warning sign in our investment analysis , you should know about...

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.

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