Anhui Zhongding Sealing Parts (SZSE:000887) Has A Pretty Healthy Balance Sheet

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 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. As with many other companies Anhui Zhongding Sealing Parts Co., Ltd. (SZSE:000887) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Anhui Zhongding Sealing Parts

What Is Anhui Zhongding Sealing Parts's Debt?

As you can see below, at the end of June 2024, Anhui Zhongding Sealing Parts had CN¥5.72b of debt, up from CN¥5.47b a year ago. Click the image for more detail. However, it does have CN¥2.72b in cash offsetting this, leading to net debt of about CN¥3.00b.

How Healthy Is Anhui Zhongding Sealing Parts' Balance Sheet?

We can see from the most recent balance sheet that Anhui Zhongding Sealing Parts had liabilities of CN¥7.49b falling due within a year, and liabilities of CN¥3.33b due beyond that. Offsetting this, it had CN¥2.72b in cash and CN¥6.57b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.53b.

Since publicly traded Anhui Zhongding Sealing Parts shares are worth a total of CN¥17.5b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Anhui Zhongding Sealing Parts's net debt is only 1.3 times its EBITDA. And its EBIT covers its interest expense a whopping 27.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Anhui Zhongding Sealing Parts grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Anhui Zhongding Sealing Parts's ability to maintain a healthy balance sheet going forward. 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. In the last three years, Anhui Zhongding Sealing Parts created free cash flow amounting to 3.5% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

The good news is that Anhui Zhongding Sealing Parts's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. When we consider the range of factors above, it looks like Anhui Zhongding Sealing Parts is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For example, we've discovered 1 warning sign for Anhui Zhongding Sealing Parts that you should be aware of before investing here.

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.