We Think Zhejiang Weiming Environment Protection (SHSE:603568) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Zhejiang Weiming Environment Protection Co., Ltd. (SHSE:603568) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Zhejiang Weiming Environment Protection

What Is Zhejiang Weiming Environment Protection's Net Debt?

As you can see below, at the end of March 2024, Zhejiang Weiming Environment Protection had CN¥6.77b of debt, up from CN¥6.20b a year ago. Click the image for more detail. On the flip side, it has CN¥2.29b in cash leading to net debt of about CN¥4.49b.

A Look At Zhejiang Weiming Environment Protection's Liabilities

Zooming in on the latest balance sheet data, we can see that Zhejiang Weiming Environment Protection had liabilities of CN¥3.41b due within 12 months and liabilities of CN¥8.31b due beyond that. Offsetting this, it had CN¥2.29b in cash and CN¥3.54b in receivables that were due within 12 months. So it has liabilities totalling CN¥5.90b more than its cash and near-term receivables, combined.

Given Zhejiang Weiming Environment Protection has a market capitalization of CN¥32.0b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Zhejiang Weiming Environment Protection's net debt is only 1.4 times its EBITDA. And its EBIT covers its interest expense a whopping 18.3 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Zhejiang Weiming Environment Protection grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. 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 Zhejiang Weiming Environment Protection can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Zhejiang Weiming Environment Protection recorded negative free cash flow, in total. 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.

Our View

Both Zhejiang Weiming Environment Protection's ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to convert EBIT to free cash flow. Considering this range of data points, we think Zhejiang Weiming Environment Protection is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Zhejiang Weiming Environment Protection you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com