We Think JiangSu Zhenjiang New Energy Equipment (SHSE:603507) Is Taking Some Risk With Its Debt

Warren Buffett famously said, '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. We note that JiangSu Zhenjiang New Energy Equipment Co., Ltd. (SHSE:603507) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for JiangSu Zhenjiang New Energy Equipment

How Much Debt Does JiangSu Zhenjiang New Energy Equipment Carry?

The chart below, which you can click on for greater detail, shows that JiangSu Zhenjiang New Energy Equipment had CN¥1.30b in debt in June 2024; about the same as the year before. However, it does have CN¥663.4m in cash offsetting this, leading to net debt of about CN¥632.4m.

How Healthy Is JiangSu Zhenjiang New Energy Equipment's Balance Sheet?

According to the last reported balance sheet, JiangSu Zhenjiang New Energy Equipment had liabilities of CN¥2.88b due within 12 months, and liabilities of CN¥859.0m due beyond 12 months. Offsetting this, it had CN¥663.4m in cash and CN¥976.9m in receivables that were due within 12 months. So it has liabilities totalling CN¥2.10b more than its cash and near-term receivables, combined.

JiangSu Zhenjiang New Energy Equipment has a market capitalization of CN¥4.58b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While JiangSu Zhenjiang New Energy Equipment's low debt to EBITDA ratio of 1.0 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 2.5 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Importantly, JiangSu Zhenjiang New Energy Equipment grew its EBIT by 47% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if JiangSu Zhenjiang New Energy Equipment 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, JiangSu Zhenjiang New Energy Equipment saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

JiangSu Zhenjiang New Energy Equipment's conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that JiangSu Zhenjiang New Energy Equipment is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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 example, we've discovered 2 warning signs for JiangSu Zhenjiang New Energy Equipment that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.