Is Zhejiang Yinlun MachineryLtd (SZSE:002126) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Zhejiang Yinlun Machinery Co.,Ltd. (SZSE:002126) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Zhejiang Yinlun MachineryLtd

What Is Zhejiang Yinlun MachineryLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Zhejiang Yinlun MachineryLtd had debt of CN¥3.59b, up from CN¥3.07b in one year. However, it also had CN¥1.97b in cash, and so its net debt is CN¥1.62b.

How Healthy Is Zhejiang Yinlun MachineryLtd's Balance Sheet?

The latest balance sheet data shows that Zhejiang Yinlun MachineryLtd had liabilities of CN¥9.14b due within a year, and liabilities of CN¥1.21b falling due after that. On the other hand, it had cash of CN¥1.97b and CN¥6.23b worth of receivables due within a year. So it has liabilities totalling CN¥2.15b more than its cash and near-term receivables, combined.

Of course, Zhejiang Yinlun MachineryLtd has a market capitalization of CN¥12.5b, 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 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.

Zhejiang Yinlun MachineryLtd's net debt is only 1.1 times its EBITDA. And its EBIT covers its interest expense a whopping 13.4 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, Zhejiang Yinlun MachineryLtd grew its EBIT by 87% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Zhejiang Yinlun MachineryLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Zhejiang Yinlun MachineryLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

The good news is that Zhejiang Yinlun MachineryLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Zhejiang Yinlun MachineryLtd 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. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Zhejiang Yinlun MachineryLtd (of which 1 is potentially serious!) 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.

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