Here's Why Qingdao CHOHO IndustrialLtd (SZSE:003033) Has A Meaningful Debt Burden

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. Importantly, Qingdao CHOHO Industrial Co.,Ltd. (SZSE:003033) does carry debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Qingdao CHOHO IndustrialLtd

How Much Debt Does Qingdao CHOHO IndustrialLtd Carry?

The chart below, which you can click on for greater detail, shows that Qingdao CHOHO IndustrialLtd had CN¥528.3m in debt in September 2024; about the same as the year before. However, it does have CN¥248.8m in cash offsetting this, leading to net debt of about CN¥279.5m.

A Look At Qingdao CHOHO IndustrialLtd's Liabilities

We can see from the most recent balance sheet that Qingdao CHOHO IndustrialLtd had liabilities of CN¥399.1m falling due within a year, and liabilities of CN¥645.4m due beyond that. Offsetting these obligations, it had cash of CN¥248.8m as well as receivables valued at CN¥447.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥348.2m.

Of course, Qingdao CHOHO IndustrialLtd has a market capitalization of CN¥3.92b, 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 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.

With net debt sitting at just 1.3 times EBITDA, Qingdao CHOHO IndustrialLtd is arguably pretty conservatively geared. And it boasts interest cover of 8.2 times, which is more than adequate. On the other hand, Qingdao CHOHO IndustrialLtd saw its EBIT drop by 2.5% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is Qingdao CHOHO IndustrialLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Qingdao CHOHO IndustrialLtd 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

Qingdao CHOHO IndustrialLtd's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to to cover its interest expense with its EBIT isn't too shabby at all. Looking at all the angles mentioned above, it does seem to us that Qingdao CHOHO IndustrialLtd is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Qingdao CHOHO IndustrialLtd that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.