Does Zoomlion Heavy Industry Science and Technology (SZSE:000157) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Zoomlion Heavy Industry Science and Technology Co., Ltd. (SZSE:000157) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Zoomlion Heavy Industry Science and Technology

What Is Zoomlion Heavy Industry Science and Technology's Net Debt?

As you can see below, Zoomlion Heavy Industry Science and Technology had CN¥21.2b of debt at March 2024, down from CN¥23.2b a year prior. On the flip side, it has CN¥15.8b in cash leading to net debt of about CN¥5.43b.

A Look At Zoomlion Heavy Industry Science and Technology's Liabilities

According to the last reported balance sheet, Zoomlion Heavy Industry Science and Technology had liabilities of CN¥49.5b due within 12 months, and liabilities of CN¥23.4b due beyond 12 months. Offsetting these obligations, it had cash of CN¥15.8b as well as receivables valued at CN¥28.4b due within 12 months. So it has liabilities totalling CN¥28.8b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Zoomlion Heavy Industry Science and Technology has a market capitalization of CN¥51.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Zoomlion Heavy Industry Science and Technology has net debt of just 1.2 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. Even more impressive was the fact that Zoomlion Heavy Industry Science and Technology grew its EBIT by 152% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zoomlion Heavy Industry Science and Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Zoomlion Heavy Industry Science and Technology recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Zoomlion Heavy Industry Science and Technology's interest cover was a real positive on this analysis, as was its EBIT growth rate. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. When we consider all the factors mentioned above, we do feel a bit cautious about Zoomlion Heavy Industry Science and Technology's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Zoomlion Heavy Industry Science and Technology is showing 3 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.