Is Zhejiang Dingli MachineryLtd (SHSE:603338) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Dingli Machinery Co.,Ltd (SHSE:603338) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Zhejiang Dingli MachineryLtd

What Is Zhejiang Dingli MachineryLtd's Debt?

The image below, which you can click on for greater detail, shows that Zhejiang Dingli MachineryLtd had debt of CN¥1.08b at the end of March 2024, a reduction from CN¥1.61b over a year. However, its balance sheet shows it holds CN¥4.02b in cash, so it actually has CN¥2.94b net cash.

How Strong Is Zhejiang Dingli MachineryLtd's Balance Sheet?

The latest balance sheet data shows that Zhejiang Dingli MachineryLtd had liabilities of CN¥4.58b due within a year, and liabilities of CN¥729.9m falling due after that. Offsetting this, it had CN¥4.02b in cash and CN¥4.06b in receivables that were due within 12 months. So it actually has CN¥2.78b more liquid assets than total liabilities.

This short term liquidity is a sign that Zhejiang Dingli MachineryLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Zhejiang Dingli MachineryLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Zhejiang Dingli MachineryLtd has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. 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 Zhejiang Dingli MachineryLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Zhejiang Dingli MachineryLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Zhejiang Dingli MachineryLtd recorded free cash flow worth 58% 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Dingli MachineryLtd has CN¥2.94b in net cash and a decent-looking balance sheet. And we liked the look of last year's 43% year-on-year EBIT growth. So we don't think Zhejiang Dingli MachineryLtd's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Zhejiang Dingli MachineryLtd .

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.