Is ShenZhen Woer Heat-Shrinkable MaterialLtd (SZSE:002130) A Risky Investment?

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. Importantly, ShenZhen Woer Heat-Shrinkable Material Co.,Ltd. (SZSE:002130) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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 ShenZhen Woer Heat-Shrinkable MaterialLtd

How Much Debt Does ShenZhen Woer Heat-Shrinkable MaterialLtd Carry?

The chart below, which you can click on for greater detail, shows that ShenZhen Woer Heat-Shrinkable MaterialLtd had CN¥1.61b in debt in September 2024; about the same as the year before. On the flip side, it has CN¥1.18b in cash leading to net debt of about CN¥421.6m.

How Healthy Is ShenZhen Woer Heat-Shrinkable MaterialLtd's Balance Sheet?

We can see from the most recent balance sheet that ShenZhen Woer Heat-Shrinkable MaterialLtd had liabilities of CN¥2.63b falling due within a year, and liabilities of CN¥1.26b due beyond that. On the other hand, it had cash of CN¥1.18b and CN¥3.02b worth of receivables due within a year. So it can boast CN¥313.4m more liquid assets than total liabilities.

This state of affairs indicates that ShenZhen Woer Heat-Shrinkable MaterialLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥30.0b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, ShenZhen Woer Heat-Shrinkable MaterialLtd has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

ShenZhen Woer Heat-Shrinkable MaterialLtd has a low net debt to EBITDA ratio of only 0.32. And its EBIT easily covers its interest expense, being 61.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, ShenZhen Woer Heat-Shrinkable MaterialLtd grew its EBIT by 41% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ShenZhen Woer Heat-Shrinkable MaterialLtd 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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, ShenZhen Woer Heat-Shrinkable MaterialLtd produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

ShenZhen Woer Heat-Shrinkable MaterialLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! Considering this range of factors, it seems to us that ShenZhen Woer Heat-Shrinkable MaterialLtd is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that ShenZhen Woer Heat-Shrinkable MaterialLtd is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.