We Think Zhejiang TongLi Transmission Technology (SZSE:301255) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Zhejiang TongLi Transmission Technology Co., Ltd. (SZSE:301255) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Zhejiang TongLi Transmission Technology

What Is Zhejiang TongLi Transmission Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhejiang TongLi Transmission Technology had CN¥49.2m of debt, an increase on CN¥28.5m, over one year. But it also has CN¥519.9m in cash to offset that, meaning it has CN¥470.7m net cash.

A Look At Zhejiang TongLi Transmission Technology's Liabilities

The latest balance sheet data shows that Zhejiang TongLi Transmission Technology had liabilities of CN¥290.3m due within a year, and liabilities of CN¥32.5m falling due after that. Offsetting these obligations, it had cash of CN¥519.9m as well as receivables valued at CN¥153.9m due within 12 months. So it actually has CN¥351.0m more liquid assets than total liabilities.

This surplus suggests that Zhejiang TongLi Transmission Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Zhejiang TongLi Transmission Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Zhejiang TongLi Transmission Technology's load is not too heavy, because its EBIT was down 23% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zhejiang TongLi Transmission Technology's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Zhejiang TongLi Transmission Technology 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. Over the last three years, Zhejiang TongLi Transmission Technology 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang TongLi Transmission Technology has CN¥470.7m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Zhejiang TongLi Transmission Technology's balance sheet. 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. Be aware that Zhejiang TongLi Transmission Technology is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.