Does Eternal Asia Supply Chain Management (SZSE:002183) Have A Healthy Balance Sheet?

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 Eternal Asia Supply Chain Management Ltd. (SZSE:002183) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Eternal Asia Supply Chain Management

What Is Eternal Asia Supply Chain Management's Debt?

The chart below, which you can click on for greater detail, shows that Eternal Asia Supply Chain Management had CN¥23.9b in debt in June 2024; about the same as the year before. However, because it has a cash reserve of CN¥9.22b, its net debt is less, at about CN¥14.6b.

How Strong Is Eternal Asia Supply Chain Management's Balance Sheet?

We can see from the most recent balance sheet that Eternal Asia Supply Chain Management had liabilities of CN¥37.8b falling due within a year, and liabilities of CN¥3.08b due beyond that. Offsetting this, it had CN¥9.22b in cash and CN¥19.1b in receivables that were due within 12 months. So its liabilities total CN¥12.6b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥15.3b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

As it happens Eternal Asia Supply Chain Management has a fairly concerning net debt to EBITDA ratio of 12.8 but very strong interest coverage of 11.4. So either it has access to very cheap long term debt or that interest expense is going to grow! We saw Eternal Asia Supply Chain Management grow its EBIT by 2.9% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But it is Eternal Asia Supply Chain Management's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Eternal Asia Supply Chain Management burned a lot of cash. 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.

Our View

To be frank both Eternal Asia Supply Chain Management's net debt to EBITDA and its track record of converting EBIT to free cash flow 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. Looking at the bigger picture, it seems clear to us that Eternal Asia Supply Chain Management's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Eternal Asia Supply Chain Management you should be aware of, and 1 of them is a bit unpleasant.

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.