These 4 Measures Indicate That Kunshan Kinglai Hygienic MaterialsLtd (SZSE:300260) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Kunshan Kinglai Hygienic Materials Co.,Ltd. (SZSE:300260) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Kunshan Kinglai Hygienic MaterialsLtd

What Is Kunshan Kinglai Hygienic MaterialsLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Kunshan Kinglai Hygienic MaterialsLtd had CN¥1.56b of debt, an increase on CN¥1.03b, over one year. On the flip side, it has CN¥406.5m in cash leading to net debt of about CN¥1.15b.

How Strong Is Kunshan Kinglai Hygienic MaterialsLtd's Balance Sheet?

We can see from the most recent balance sheet that Kunshan Kinglai Hygienic MaterialsLtd had liabilities of CN¥2.15b falling due within a year, and liabilities of CN¥528.3m due beyond that. Offsetting this, it had CN¥406.5m in cash and CN¥811.5m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.46b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Kunshan Kinglai Hygienic MaterialsLtd is worth CN¥6.72b, 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). 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).

With net debt to EBITDA of 2.7 Kunshan Kinglai Hygienic MaterialsLtd has a fairly noticeable amount of debt. But the high interest coverage of 7.3 suggests it can easily service that debt. Shareholders should be aware that Kunshan Kinglai Hygienic MaterialsLtd's EBIT was down 23% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Kunshan Kinglai Hygienic MaterialsLtd 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 always check how much of that EBIT is translated into free cash flow. During the last three years, Kunshan Kinglai Hygienic MaterialsLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Kunshan Kinglai Hygienic MaterialsLtd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, we think it's fair to say that Kunshan Kinglai Hygienic MaterialsLtd has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. We've identified 1 warning sign with Kunshan Kinglai Hygienic MaterialsLtd , and understanding them should be part of your investment process.

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.