Is Ningbo ZhongDa Leader Intelligent Transmission (SZSE:002896) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Ningbo ZhongDa Leader Intelligent Transmission Co., Ltd. (SZSE:002896) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ningbo ZhongDa Leader Intelligent Transmission

What Is Ningbo ZhongDa Leader Intelligent Transmission's Debt?

The chart below, which you can click on for greater detail, shows that Ningbo ZhongDa Leader Intelligent Transmission had CN¥126.9m in debt in March 2024; about the same as the year before. However, it also had CN¥116.2m in cash, and so its net debt is CN¥10.7m.

A Look At Ningbo ZhongDa Leader Intelligent Transmission's Liabilities

The latest balance sheet data shows that Ningbo ZhongDa Leader Intelligent Transmission had liabilities of CN¥376.7m due within a year, and liabilities of CN¥105.4m falling due after that. On the other hand, it had cash of CN¥116.2m and CN¥298.0m worth of receivables due within a year. So its liabilities total CN¥67.8m more than the combination of its cash and short-term receivables.

Having regard to Ningbo ZhongDa Leader Intelligent Transmission's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥4.12b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Ningbo ZhongDa Leader Intelligent Transmission has a very light debt load indeed.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With debt at a measly 0.08 times EBITDA and EBIT covering interest a whopping 16.8 times, it's clear that Ningbo ZhongDa Leader Intelligent Transmission is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. Another good sign is that Ningbo ZhongDa Leader Intelligent Transmission has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. 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 Ningbo ZhongDa Leader Intelligent Transmission 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ningbo ZhongDa Leader Intelligent Transmission saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

The good news is that Ningbo ZhongDa Leader Intelligent Transmission's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Ningbo ZhongDa Leader Intelligent Transmission can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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 Ningbo ZhongDa Leader Intelligent Transmission is showing 1 warning sign in our investment analysis , you should know about...

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.

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