We Think Xiangyang Changyuandonggu Industry (SHSE:603950) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Xiangyang Changyuandonggu Industry Co., Ltd. (SHSE:603950) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Xiangyang Changyuandonggu Industry

What Is Xiangyang Changyuandonggu Industry's Net Debt?

As you can see below, at the end of September 2024, Xiangyang Changyuandonggu Industry had CN¥770.2m of debt, up from CN¥661.2m a year ago. Click the image for more detail. However, it does have CN¥531.2m in cash offsetting this, leading to net debt of about CN¥238.9m.

How Strong Is Xiangyang Changyuandonggu Industry's Balance Sheet?

According to the last reported balance sheet, Xiangyang Changyuandonggu Industry had liabilities of CN¥1.32b due within 12 months, and liabilities of CN¥1.01b due beyond 12 months. Offsetting these obligations, it had cash of CN¥531.2m as well as receivables valued at CN¥933.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥858.4m.

Given Xiangyang Changyuandonggu Industry has a market capitalization of CN¥8.02b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Xiangyang Changyuandonggu Industry has a low debt to EBITDA ratio of only 0.58. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. Another good sign is that Xiangyang Changyuandonggu Industry has been able to increase its EBIT by 30% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is Xiangyang Changyuandonggu Industry'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Xiangyang Changyuandonggu Industry recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Xiangyang Changyuandonggu Industry's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. 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 Xiangyang Changyuandonggu Industry 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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Xiangyang Changyuandonggu Industry you should be aware of, and 1 of them is significant.

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.