These 4 Measures Indicate That Zhejiang Shuanghuan DrivelineLtd (SZSE:002472) 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 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. Importantly, Zhejiang Shuanghuan Driveline Co.,Ltd. (SZSE:002472) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Zhejiang Shuanghuan DrivelineLtd

What Is Zhejiang Shuanghuan DrivelineLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Zhejiang Shuanghuan DrivelineLtd had CN¥2.63b of debt, an increase on CN¥2.32b, over one year. However, it does have CN¥1.50b in cash offsetting this, leading to net debt of about CN¥1.12b.

How Strong Is Zhejiang Shuanghuan DrivelineLtd's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Shuanghuan DrivelineLtd had liabilities of CN¥4.44b falling due within a year, and liabilities of CN¥1.23b due beyond that. Offsetting these obligations, it had cash of CN¥1.50b as well as receivables valued at CN¥2.52b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.65b.

Given Zhejiang Shuanghuan DrivelineLtd has a market capitalization of CN¥17.4b, 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.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Zhejiang Shuanghuan DrivelineLtd's net debt is only 0.66 times its EBITDA. And its EBIT easily covers its interest expense, being 28.5 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Zhejiang Shuanghuan DrivelineLtd grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhejiang Shuanghuan DrivelineLtd 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Zhejiang Shuanghuan DrivelineLtd burned a lot of cash. 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

Happily, Zhejiang Shuanghuan DrivelineLtd'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. All these things considered, it appears that Zhejiang Shuanghuan DrivelineLtd 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. Over time, share prices tend to follow earnings per share, so if you're interested in Zhejiang Shuanghuan DrivelineLtd, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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