Warren Buffett famously said, '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 Jiangsu Zhongchao Holding Co., Ltd. (SZSE:002471) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Jiangsu Zhongchao Holding Carry?
The chart below, which you can click on for greater detail, shows that Jiangsu Zhongchao Holding had CN¥1.98b in debt in September 2024; about the same as the year before. However, it does have CN¥811.9m in cash offsetting this, leading to net debt of about CN¥1.16b.
A Look At Jiangsu Zhongchao Holding's Liabilities
The latest balance sheet data shows that Jiangsu Zhongchao Holding had liabilities of CN¥3.97b due within a year, and liabilities of CN¥83.2m falling due after that. On the other hand, it had cash of CN¥811.9m and CN¥2.55b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥692.3m.
Since publicly traded Jiangsu Zhongchao Holding shares are worth a total of CN¥3.87b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Jiangsu Zhongchao Holding shareholders face the double whammy of a high net debt to EBITDA ratio (11.3), and fairly weak interest coverage, since EBIT is just 0.77 times the interest expense. The debt burden here is substantial. One redeeming factor for Jiangsu Zhongchao Holding is that it turned last year's EBIT loss into a gain of CN¥50m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jiangsu Zhongchao Holding'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Jiangsu Zhongchao Holding actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Our View
We weren't impressed with Jiangsu Zhongchao Holding's net debt to EBITDA, and its interest cover made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble converting EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about Jiangsu Zhongchao Holding'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. 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. For instance, we've identified 2 warning signs for Jiangsu Zhongchao Holding (1 can't be ignored) you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
