Is Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology (SHSE:603300) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology Co., Ltd. (SHSE:603300) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology

What Is Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology's Net Debt?

As you can see below, at the end of September 2024, Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology had CN¥4.61b of debt, up from CN¥3.66b a year ago. Click the image for more detail. However, it does have CN¥314.1m in cash offsetting this, leading to net debt of about CN¥4.30b.

How Strong Is Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology's Balance Sheet?

According to the last reported balance sheet, Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology had liabilities of CN¥7.18b due within 12 months, and liabilities of CN¥8.31b due beyond 12 months. Offsetting these obligations, it had cash of CN¥314.1m as well as receivables valued at CN¥4.51b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥10.7b.

This is a mountain of leverage relative to its market capitalization of CN¥10.7b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

While Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology has a quite reasonable net debt to EBITDA multiple of 2.5, its interest cover seems weak, at 2.1. This does have us wondering if the company pays high interest because it is considered risky. Either way there's no doubt the stock is using meaningful leverage. We saw Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology grow its EBIT by 7.1% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 Haikong Nanke Huatie Digital Intelligence and Technology'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 most recent three years, Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology's interest cover and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. We think that Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Zhejiang Haikong Nanke Huatie Digital Intelligence and Technology (of which 1 makes us a bit uncomfortable!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.