Is Zhe Jiang Headman MachineryLtd (SHSE:688577) A Risky Investment?

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.' 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 Zhe Jiang Headman Machinery Co.,Ltd. (SHSE:688577) 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Zhe Jiang Headman MachineryLtd

What Is Zhe Jiang Headman MachineryLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhe Jiang Headman MachineryLtd had CN¥130.2m of debt, an increase on CN¥88.2m, over one year. But it also has CN¥177.6m in cash to offset that, meaning it has CN¥47.4m net cash.

How Strong Is Zhe Jiang Headman MachineryLtd's Balance Sheet?

The latest balance sheet data shows that Zhe Jiang Headman MachineryLtd had liabilities of CN¥524.3m due within a year, and liabilities of CN¥99.3m falling due after that. Offsetting this, it had CN¥177.6m in cash and CN¥257.6m in receivables that were due within 12 months. So its liabilities total CN¥188.4m more than the combination of its cash and short-term receivables.

Since publicly traded Zhe Jiang Headman MachineryLtd shares are worth a total of CN¥3.86b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Zhe Jiang Headman MachineryLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Zhe Jiang Headman MachineryLtd's EBIT was down 52% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is Zhe Jiang Headman MachineryLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Zhe Jiang Headman 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 last three years, Zhe Jiang Headman MachineryLtd 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.

Summing Up

We could understand if investors are concerned about Zhe Jiang Headman MachineryLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥47.4m. So although we see some areas for improvement, we're not too worried about Zhe Jiang Headman MachineryLtd's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 6 warning signs for Zhe Jiang Headman MachineryLtd (of which 2 can't be ignored!) you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.