Here's Why Hunan Yuneng New Energy Battery MaterialLtd (SZSE:301358) Has A Meaningful Debt Burden

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Hunan Yuneng New Energy Battery Material Co.,Ltd. (SZSE:301358) 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?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Hunan Yuneng New Energy Battery MaterialLtd

What Is Hunan Yuneng New Energy Battery MaterialLtd's Debt?

The image below, which you can click on for greater detail, shows that Hunan Yuneng New Energy Battery MaterialLtd had debt of CN¥4.61b at the end of December 2023, a reduction from CN¥6.32b over a year. However, it does have CN¥1.89b in cash offsetting this, leading to net debt of about CN¥2.72b.

How Healthy Is Hunan Yuneng New Energy Battery MaterialLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hunan Yuneng New Energy Battery MaterialLtd had liabilities of CN¥12.5b due within 12 months and liabilities of CN¥3.01b due beyond that. Offsetting these obligations, it had cash of CN¥1.89b as well as receivables valued at CN¥9.47b due within 12 months. So it has liabilities totalling CN¥4.12b more than its cash and near-term receivables, combined.

Of course, Hunan Yuneng New Energy Battery MaterialLtd has a market capitalization of CN¥26.4b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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).

Hunan Yuneng New Energy Battery MaterialLtd has a low net debt to EBITDA ratio of only 0.78. And its EBIT covers its interest expense a whopping 10.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for Hunan Yuneng New Energy Battery MaterialLtd if management cannot prevent a repeat of the 40% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Hunan Yuneng New Energy Battery MaterialLtd 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. During the last three years, Hunan Yuneng New Energy Battery MaterialLtd 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 Hunan Yuneng New Energy Battery MaterialLtd'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. Once we consider all the factors above, together, it seems to us that Hunan Yuneng New Energy Battery MaterialLtd's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. Case in point: We've spotted 3 warning signs for Hunan Yuneng New Energy Battery MaterialLtd you should be aware of, and 1 of them is concerning.

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.