Here's Why FULONGMA GROUPLtd (SHSE:603686) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that FULONGMA GROUP Co.,Ltd. (SHSE:603686) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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

View our latest analysis for FULONGMA GROUPLtd

What Is FULONGMA GROUPLtd's Net Debt?

As you can see below, at the end of September 2024, FULONGMA GROUPLtd had CN¥832.6m of debt, up from CN¥287.4m a year ago. Click the image for more detail. However, it does have CN¥762.4m in cash offsetting this, leading to net debt of about CN¥70.2m.

How Strong Is FULONGMA GROUPLtd's Balance Sheet?

The latest balance sheet data shows that FULONGMA GROUPLtd had liabilities of CN¥2.46b due within a year, and liabilities of CN¥555.7m falling due after that. Offsetting these obligations, it had cash of CN¥762.4m as well as receivables valued at CN¥3.53b due within 12 months. So it can boast CN¥1.27b more liquid assets than total liabilities.

This surplus suggests that FULONGMA GROUPLtd is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

FULONGMA GROUPLtd's net debt is only 0.14 times its EBITDA. And its EBIT covers its interest expense a whopping 162 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for FULONGMA GROUPLtd if management cannot prevent a repeat of the 27% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if FULONGMA GROUPLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, FULONGMA GROUPLtd actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

FULONGMA GROUPLtd's EBIT growth rate was a real negative on this analysis, as was its conversion of EBIT to free cash flow. But like a ballerina ending on a perfect pirouette, it has not trouble covering its interest expense with its EBIT. Considering this range of data points, we think FULONGMA GROUPLtd is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that FULONGMA GROUPLtd is showing 2 warning signs in our investment analysis , you should know about...

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.