Is Zhejiang Wanma (SZSE:002276) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Zhejiang Wanma Co., Ltd. (SZSE:002276) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Zhejiang Wanma

How Much Debt Does Zhejiang Wanma Carry?

As you can see below, Zhejiang Wanma had CN¥1.54b of debt at December 2023, down from CN¥1.71b a year prior. However, its balance sheet shows it holds CN¥3.43b in cash, so it actually has CN¥1.89b net cash.

How Healthy Is Zhejiang Wanma's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Wanma had liabilities of CN¥7.07b falling due within a year, and liabilities of CN¥1.26b due beyond that. Offsetting these obligations, it had cash of CN¥3.43b as well as receivables valued at CN¥5.64b due within 12 months. So it actually has CN¥736.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Zhejiang Wanma could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Zhejiang Wanma has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Zhejiang Wanma has boosted its EBIT by 37%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Zhejiang Wanma 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Zhejiang Wanma has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Zhejiang Wanma recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Wanma has CN¥1.89b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 37% over the last year. So is Zhejiang Wanma's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Zhejiang Wanma, you may well want to click here to check an interactive graph of its earnings per share history.

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.