We Think Xiangtan Yongda Machinery Manufacturing (SZSE:001239) Is Taking Some Risk With Its Debt

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. As with many other companies Xiangtan Yongda Machinery Manufacturing Co., Ltd. (SZSE:001239) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Xiangtan Yongda Machinery Manufacturing

What Is Xiangtan Yongda Machinery Manufacturing's Debt?

The image below, which you can click on for greater detail, shows that Xiangtan Yongda Machinery Manufacturing had debt of CN¥556.5m at the end of September 2024, a reduction from CN¥603.9m over a year. However, because it has a cash reserve of CN¥509.4m, its net debt is less, at about CN¥47.0m.

How Strong Is Xiangtan Yongda Machinery Manufacturing's Balance Sheet?

The latest balance sheet data shows that Xiangtan Yongda Machinery Manufacturing had liabilities of CN¥599.0m due within a year, and liabilities of CN¥289.9m falling due after that. Offsetting these obligations, it had cash of CN¥509.4m as well as receivables valued at CN¥776.2m due within 12 months. So it actually has CN¥396.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Xiangtan Yongda Machinery Manufacturing could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, Xiangtan Yongda Machinery Manufacturing has a very light debt load indeed.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Xiangtan Yongda Machinery Manufacturing has a low net debt to EBITDA ratio of only 0.38. And its EBIT covers its interest expense a whopping 21.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact Xiangtan Yongda Machinery Manufacturing's saving grace is its low debt levels, because its EBIT has tanked 35% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Xiangtan Yongda Machinery Manufacturing'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. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Xiangtan Yongda Machinery Manufacturing 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

While Xiangtan Yongda Machinery Manufacturing's EBIT growth rate has us nervous. To wit both its interest cover and net debt to EBITDA were encouraging signs. We think that Xiangtan Yongda Machinery Manufacturing's debt does make it a bit risky, after considering the aforementioned data points together. 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 1 warning sign for Xiangtan Yongda Machinery Manufacturing that you should be aware of before investing here.

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.