Is Bingshan Refrigeration & Heat Transfer Technologies (SZSE:000530) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Bingshan Refrigeration & Heat Transfer Technologies Co., Ltd. (SZSE:000530) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Bingshan Refrigeration & Heat Transfer Technologies

What Is Bingshan Refrigeration & Heat Transfer Technologies's Net Debt?

The image below, which you can click on for greater detail, shows that Bingshan Refrigeration & Heat Transfer Technologies had debt of CN¥1.05b at the end of September 2024, a reduction from CN¥1.13b over a year. However, because it has a cash reserve of CN¥747.2m, its net debt is less, at about CN¥307.5m.

How Healthy Is Bingshan Refrigeration & Heat Transfer Technologies' Balance Sheet?

According to the last reported balance sheet, Bingshan Refrigeration & Heat Transfer Technologies had liabilities of CN¥3.73b due within 12 months, and liabilities of CN¥786.4m due beyond 12 months. On the other hand, it had cash of CN¥747.2m and CN¥2.67b worth of receivables due within a year. So its liabilities total CN¥1.10b more than the combination of its cash and short-term receivables.

Bingshan Refrigeration & Heat Transfer Technologies has a market capitalization of CN¥3.87b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Bingshan Refrigeration & Heat Transfer Technologies's net debt is only 1.1 times its EBITDA. And its EBIT easily covers its interest expense, being 13.4 times the size. So we're pretty relaxed about its super-conservative use of debt. It was also good to see that despite losing money on the EBIT line last year, Bingshan Refrigeration & Heat Transfer Technologies turned things around in the last 12 months, delivering and EBIT of CN¥89m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Bingshan Refrigeration & Heat Transfer Technologies can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Bingshan Refrigeration & Heat Transfer Technologies recorded negative free cash flow, in total. 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

On our analysis Bingshan Refrigeration & Heat Transfer Technologies's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. In particular, conversion of EBIT to free cash flow gives us cold feet. When we consider all the factors mentioned above, we do feel a bit cautious about Bingshan Refrigeration & Heat Transfer Technologies's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Case in point: We've spotted 2 warning signs for Bingshan Refrigeration & Heat Transfer Technologies you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.