Yantai Zhenghai Magnetic Material (SZSE:300224) Has A Somewhat Strained Balance Sheet

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Yantai Zhenghai Magnetic Material Co., Ltd. (SZSE:300224) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Yantai Zhenghai Magnetic Material

What Is Yantai Zhenghai Magnetic Material's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Yantai Zhenghai Magnetic Material had debt of CN¥1.24b, up from CN¥1.17b in one year. But on the other hand it also has CN¥1.94b in cash, leading to a CN¥697.7m net cash position.

How Strong Is Yantai Zhenghai Magnetic Material's Balance Sheet?

According to the last reported balance sheet, Yantai Zhenghai Magnetic Material had liabilities of CN¥2.76b due within 12 months, and liabilities of CN¥1.33b due beyond 12 months. Offsetting this, it had CN¥1.94b in cash and CN¥1.93b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥226.1m.

Of course, Yantai Zhenghai Magnetic Material has a market capitalization of CN¥9.81b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Yantai Zhenghai Magnetic Material also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Yantai Zhenghai Magnetic Material's load is not too heavy, because its EBIT was down 38% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Yantai Zhenghai Magnetic Material's ability to maintain a healthy balance sheet going forward. 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. While Yantai Zhenghai Magnetic Material 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. Considering the last three years, Yantai Zhenghai Magnetic Material actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

We could understand if investors are concerned about Yantai Zhenghai Magnetic Material's liabilities, but we can be reassured by the fact it has has net cash of CN¥697.7m. So while Yantai Zhenghai Magnetic Material does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Yantai Zhenghai Magnetic Material you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.