Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Chengdu Xinzhu Road&Bridge Machinery Co.,LTD (SZSE:002480) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Chengdu Xinzhu Road&Bridge MachineryLTD's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2024 Chengdu Xinzhu Road&Bridge MachineryLTD had CN¥7.56b of debt, an increase on CN¥5.90b, over one year. On the flip side, it has CN¥1.39b in cash leading to net debt of about CN¥6.17b.
How Healthy Is Chengdu Xinzhu Road&Bridge MachineryLTD's Balance Sheet?
The latest balance sheet data shows that Chengdu Xinzhu Road&Bridge MachineryLTD had liabilities of CN¥5.63b due within a year, and liabilities of CN¥6.19b falling due after that. Offsetting this, it had CN¥1.39b in cash and CN¥3.67b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.76b.
This deficit casts a shadow over the CN¥3.66b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Chengdu Xinzhu Road&Bridge MachineryLTD would likely require a major re-capitalisation if it had to pay its creditors today.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Chengdu Xinzhu Road&Bridge MachineryLTD shareholders face the double whammy of a high net debt to EBITDA ratio (11.8), and fairly weak interest coverage, since EBIT is just 0.55 times the interest expense. This means we'd consider it to have a heavy debt load. Looking on the bright side, Chengdu Xinzhu Road&Bridge MachineryLTD boosted its EBIT by a silky 68% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chengdu Xinzhu Road&Bridge MachineryLTD's earnings that will influence how the balance sheet holds up in the future. 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.
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. During the last three years, Chengdu Xinzhu Road&Bridge MachineryLTD 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
To be frank both Chengdu Xinzhu Road&Bridge MachineryLTD's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. After considering the datapoints discussed, we think Chengdu Xinzhu Road&Bridge MachineryLTD has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Chengdu Xinzhu Road&Bridge MachineryLTD , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
