These 4 Measures Indicate That Zhejiang Shuanghuan DrivelineLtd (SZSE:002472) Is Using Debt Reasonably Well

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. We note that Zhejiang Shuanghuan Driveline Co.,Ltd. (SZSE:002472) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. 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.

View our latest analysis for Zhejiang Shuanghuan DrivelineLtd

What Is Zhejiang Shuanghuan DrivelineLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhejiang Shuanghuan DrivelineLtd had CN¥2.25b of debt, an increase on CN¥2.12b, over one year. On the flip side, it has CN¥1.05b in cash leading to net debt of about CN¥1.20b.

How Strong Is Zhejiang Shuanghuan DrivelineLtd's Balance Sheet?

The latest balance sheet data shows that Zhejiang Shuanghuan DrivelineLtd had liabilities of CN¥4.41b due within a year, and liabilities of CN¥1.18b falling due after that. Offsetting these obligations, it had cash of CN¥1.05b as well as receivables valued at CN¥2.82b due within 12 months. So it has liabilities totalling CN¥1.72b more than its cash and near-term receivables, combined.

Given Zhejiang Shuanghuan DrivelineLtd has a market capitalization of CN¥26.9b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

Zhejiang Shuanghuan DrivelineLtd has a low net debt to EBITDA ratio of only 0.63. And its EBIT easily covers its interest expense, being 32.4 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Zhejiang Shuanghuan DrivelineLtd has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. 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 Zhejiang Shuanghuan DrivelineLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Zhejiang Shuanghuan DrivelineLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Happily, Zhejiang Shuanghuan DrivelineLtd's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Zhejiang Shuanghuan DrivelineLtd can handle its debt fairly comfortably. 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.

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.