We Think Zhuzhou Kibing GroupLtd (SHSE:601636) Is Taking Some Risk With Its Debt

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 Zhuzhou Kibing Group Co.,Ltd (SHSE:601636) 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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Zhuzhou Kibing GroupLtd

What Is Zhuzhou Kibing GroupLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Zhuzhou Kibing GroupLtd had debt of CN¥12.2b, up from CN¥7.50b in one year. However, it also had CN¥3.40b in cash, and so its net debt is CN¥8.82b.

How Healthy Is Zhuzhou Kibing GroupLtd's Balance Sheet?

The latest balance sheet data shows that Zhuzhou Kibing GroupLtd had liabilities of CN¥7.07b due within a year, and liabilities of CN¥11.3b falling due after that. On the other hand, it had cash of CN¥3.40b and CN¥2.26b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥12.7b.

This is a mountain of leverage relative to its market capitalization of CN¥17.8b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). 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).

We'd say that Zhuzhou Kibing GroupLtd's moderate net debt to EBITDA ratio ( being 2.3), indicates prudence when it comes to debt. And its strong interest cover of 13.4 times, makes us even more comfortable. Pleasingly, Zhuzhou Kibing GroupLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 191% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhuzhou Kibing GroupLtd's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Zhuzhou Kibing GroupLtd 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

While Zhuzhou Kibing GroupLtd's conversion of EBIT to free cash flow has us nervous. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that Zhuzhou Kibing GroupLtd 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. However, not all investment risk resides within the balance sheet - far from it. Be aware that Zhuzhou Kibing GroupLtd is showing 3 warning signs in our investment analysis , and 2 of those are a bit concerning...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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