These 4 Measures Indicate That Zhejiang Wanfeng Auto Wheel (SZSE:002085) Is Using Debt Reasonably Well

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.' 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. We note that Zhejiang Wanfeng Auto Wheel Co., Ltd. (SZSE:002085) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Zhejiang Wanfeng Auto Wheel

How Much Debt Does Zhejiang Wanfeng Auto Wheel Carry?

The image below, which you can click on for greater detail, shows that Zhejiang Wanfeng Auto Wheel had debt of CN¥4.33b at the end of March 2024, a reduction from CN¥5.39b over a year. However, it also had CN¥1.92b in cash, and so its net debt is CN¥2.41b.

A Look At Zhejiang Wanfeng Auto Wheel's Liabilities

According to the last reported balance sheet, Zhejiang Wanfeng Auto Wheel had liabilities of CN¥6.96b due within 12 months, and liabilities of CN¥1.18b due beyond 12 months. On the other hand, it had cash of CN¥1.92b and CN¥4.38b worth of receivables due within a year. So it has liabilities totalling CN¥1.83b more than its cash and near-term receivables, combined.

Of course, Zhejiang Wanfeng Auto Wheel has a market capitalization of CN¥27.2b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

With net debt sitting at just 1.1 times EBITDA, Zhejiang Wanfeng Auto Wheel is arguably pretty conservatively geared. And it boasts interest cover of 7.6 times, which is more than adequate. The good news is that Zhejiang Wanfeng Auto Wheel has increased its EBIT by 8.3% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zhejiang Wanfeng Auto Wheel's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. During the last three years, Zhejiang Wanfeng Auto Wheel produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Zhejiang Wanfeng Auto Wheel's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And we also thought its net debt to EBITDA was a positive. Taking all this data into account, it seems to us that Zhejiang Wanfeng Auto Wheel 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. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Zhejiang Wanfeng Auto Wheel (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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.