Is Zhejiang RIFA Precision Machinery (SZSE:002520) Using Too Much Debt?

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 can see that Zhejiang RIFA Precision Machinery Co., Ltd. (SZSE:002520) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Zhejiang RIFA Precision Machinery

How Much Debt Does Zhejiang RIFA Precision Machinery Carry?

You can click the graphic below for the historical numbers, but it shows that Zhejiang RIFA Precision Machinery had CN¥1.40b of debt in June 2024, down from CN¥1.62b, one year before. However, it does have CN¥291.5m in cash offsetting this, leading to net debt of about CN¥1.11b.

A Look At Zhejiang RIFA Precision Machinery's Liabilities

The latest balance sheet data shows that Zhejiang RIFA Precision Machinery had liabilities of CN¥2.47b due within a year, and liabilities of CN¥272.6m falling due after that. Offsetting these obligations, it had cash of CN¥291.5m as well as receivables valued at CN¥484.7m due within 12 months. So its liabilities total CN¥1.97b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Zhejiang RIFA Precision Machinery is worth CN¥4.25b, and thus could probably raise enough capital to shore up 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 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Zhejiang RIFA Precision Machinery's debt to EBITDA ratio (3.8) suggests that it uses some debt, its interest cover is very weak, at 0.87, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The silver lining is that Zhejiang RIFA Precision Machinery grew its EBIT by 310% last year, which nourishing like the idealism of youth. If that earnings trend continues it will make its debt load much more manageable in the future. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Zhejiang RIFA Precision Machinery will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Zhejiang RIFA Precision Machinery actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that Zhejiang RIFA Precision Machinery's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But we must concede we find its interest cover has the opposite effect. All these things considered, it appears that Zhejiang RIFA Precision Machinery can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. For instance, we've identified 2 warning signs for Zhejiang RIFA Precision Machinery (1 is significant) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.