The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Zhuzhou Smelter Group Co.,Ltd. (SHSE:600961) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is Zhuzhou Smelter GroupLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zhuzhou Smelter GroupLtd had CN¥2.02b of debt in September 2024, down from CN¥2.95b, one year before. On the flip side, it has CN¥463.9m in cash leading to net debt of about CN¥1.55b.

A Look At Zhuzhou Smelter GroupLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Zhuzhou Smelter GroupLtd had liabilities of CN¥4.09b due within 12 months and liabilities of CN¥548.4m due beyond that. Offsetting this, it had CN¥463.9m in cash and CN¥785.9m in receivables that were due within 12 months. So it has liabilities totalling CN¥3.39b more than its cash and near-term receivables, combined.

Zhuzhou Smelter GroupLtd has a market capitalization of CN¥9.04b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Zhuzhou Smelter GroupLtd's net debt is only 1.4 times its EBITDA. And its EBIT covers its interest expense a whopping 43.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Zhuzhou Smelter GroupLtd saw its EBIT decline by 2.5% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhuzhou Smelter GroupLtd can strengthen its balance sheet over time. 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Zhuzhou Smelter GroupLtd generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Zhuzhou Smelter GroupLtd's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its EBIT growth rate does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Zhuzhou Smelter GroupLtd can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Zhuzhou Smelter GroupLtd's earnings per share history for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.