These 4 Measures Indicate That Wolong Electric GroupLtd (SHSE:600580) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Wolong Electric Group Co.,Ltd. (SHSE:600580) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Wolong Electric GroupLtd

What Is Wolong Electric GroupLtd's Debt?

As you can see below, at the end of September 2024, Wolong Electric GroupLtd had CN¥6.93b of debt, up from CN¥6.62b a year ago. Click the image for more detail. However, it also had CN¥2.87b in cash, and so its net debt is CN¥4.06b.

A Look At Wolong Electric GroupLtd's Liabilities

The latest balance sheet data shows that Wolong Electric GroupLtd had liabilities of CN¥11.6b due within a year, and liabilities of CN¥3.19b falling due after that. Offsetting this, it had CN¥2.87b in cash and CN¥7.08b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.82b.

Given Wolong Electric GroupLtd has a market capitalization of CN¥26.7b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Wolong Electric GroupLtd has a debt to EBITDA ratio of 2.5 and its EBIT covered its interest expense 4.2 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, Wolong Electric GroupLtd's EBIT fell a jaw-dropping 21% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Wolong Electric GroupLtd can strengthen its balance sheet over time. 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 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. In the last three years, Wolong Electric GroupLtd's free cash flow amounted to 29% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over Wolong Electric GroupLtd's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least its level of total liabilities is not so bad. Once we consider all the factors above, together, it seems to us that Wolong Electric GroupLtd's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Wolong Electric GroupLtd is showing 2 warning signs in our investment analysis , you should know about...

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.