Is Xiamen Zhongchuang Environmental Technology (SZSE:300056) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Xiamen Zhongchuang Environmental Technology Co., Ltd (SZSE:300056) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Xiamen Zhongchuang Environmental Technology

What Is Xiamen Zhongchuang Environmental Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that Xiamen Zhongchuang Environmental Technology had CN¥205.4m of debt in September 2024, down from CN¥287.1m, one year before. However, it also had CN¥30.7m in cash, and so its net debt is CN¥174.7m.

A Look At Xiamen Zhongchuang Environmental Technology's Liabilities

We can see from the most recent balance sheet that Xiamen Zhongchuang Environmental Technology had liabilities of CN¥648.2m falling due within a year, and liabilities of CN¥76.8m due beyond that. Offsetting this, it had CN¥30.7m in cash and CN¥280.6m in receivables that were due within 12 months. So it has liabilities totalling CN¥413.6m more than its cash and near-term receivables, combined.

Since publicly traded Xiamen Zhongchuang Environmental Technology shares are worth a total of CN¥5.55b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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 Xiamen Zhongchuang Environmental Technology 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.

Over 12 months, Xiamen Zhongchuang Environmental Technology made a loss at the EBIT level, and saw its revenue drop to CN¥456m, which is a fall of 20%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Xiamen Zhongchuang Environmental Technology's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥122m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥169m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Xiamen Zhongchuang Environmental Technology is showing 2 warning signs in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.