These 4 Measures Indicate That Anhui Zhongding Sealing Parts (SZSE:000887) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Anhui Zhongding Sealing Parts had CN¥5.78b of debt, an increase on CN¥5.31b, over one year. On the flip side, it has CN¥2.89b in cash leading to net debt of about CN¥2.89b.

How Strong 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¥7.79b falling due within a year, and liabilities of CN¥3.37b due beyond that. Offsetting these obligations, it had cash of CN¥2.89b as well as receivables valued at CN¥5.67b due within 12 months. So its liabilities total CN¥2.60b more than the combination of its cash and short-term receivables.

Of course, Anhui Zhongding Sealing Parts has a market capitalization of CN¥19.5b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Anhui Zhongding Sealing Parts's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 15.2 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 Anhui Zhongding Sealing Parts has boosted its EBIT by 45%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Anhui Zhongding Sealing Parts reported free cash flow worth 12% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Happily, Anhui Zhongding Sealing Parts's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that Anhui Zhongding Sealing Parts takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. Be aware that Anhui Zhongding Sealing Parts is showing 1 warning sign in our investment analysis , you should know about...

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.