Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Zhejiang Shuanghuan Driveline Co.,Ltd. (SZSE:002472) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Zhejiang Shuanghuan DrivelineLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhejiang Shuanghuan DrivelineLtd had CN¥2.25b of debt, an increase on CN¥2.12b, over one year. On the flip side, it has CN¥1.05b in cash leading to net debt of about CN¥1.20b.

How Healthy Is Zhejiang Shuanghuan DrivelineLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zhejiang Shuanghuan DrivelineLtd had liabilities of CN¥4.41b due within 12 months and liabilities of CN¥1.18b due beyond that. Offsetting this, it had CN¥1.05b in cash and CN¥2.82b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.72b more than its cash and near-term receivables, combined.

Given Zhejiang Shuanghuan DrivelineLtd has a market capitalization of CN¥26.3b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Zhejiang Shuanghuan DrivelineLtd has a low net debt to EBITDA ratio of only 0.63. And its EBIT easily covers its interest expense, being 32.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Zhejiang Shuanghuan DrivelineLtd has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhejiang Shuanghuan DrivelineLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, Zhejiang Shuanghuan DrivelineLtd actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Happily, Zhejiang Shuanghuan DrivelineLtd's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Zhejiang Shuanghuan DrivelineLtd can comfortably handle its current debt levels. 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 Zhejiang Shuanghuan DrivelineLtd's earnings per share history for free.

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.