These 4 Measures Indicate That Ningbo ZhongDa Leader Intelligent Transmission (SZSE:002896) Is Using Debt Reasonably Well

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 Ningbo ZhongDa Leader Intelligent Transmission Co., Ltd. (SZSE:002896) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. 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.

Check out our latest analysis for Ningbo ZhongDa Leader Intelligent Transmission

What Is Ningbo ZhongDa Leader Intelligent Transmission's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Ningbo ZhongDa Leader Intelligent Transmission had CN¥140.3m of debt, an increase on CN¥130.1m, over one year. However, it does have CN¥95.9m in cash offsetting this, leading to net debt of about CN¥44.4m.

A Look At Ningbo ZhongDa Leader Intelligent Transmission's Liabilities

We can see from the most recent balance sheet that Ningbo ZhongDa Leader Intelligent Transmission had liabilities of CN¥376.2m falling due within a year, and liabilities of CN¥84.4m due beyond that. Offsetting these obligations, it had cash of CN¥95.9m as well as receivables valued at CN¥384.2m due within 12 months. So it can boast CN¥19.5m more liquid assets than total liabilities.

Having regard to Ningbo ZhongDa Leader Intelligent Transmission's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥5.84b company is short on cash, but still worth keeping an eye on the 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). 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).

Ningbo ZhongDa Leader Intelligent Transmission's net debt is only 0.33 times its EBITDA. And its EBIT covers its interest expense a whopping 64.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Ningbo ZhongDa Leader Intelligent Transmission's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Ningbo ZhongDa Leader Intelligent Transmission 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

Ningbo ZhongDa Leader Intelligent Transmission's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. Considering this range of data points, we think Ningbo ZhongDa Leader Intelligent Transmission is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 example, we've discovered 1 warning sign for Ningbo ZhongDa Leader Intelligent Transmission that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.