These 4 Measures Indicate That Zhejiang Taihua New Material Group (SHSE:603055) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Zhejiang Taihua New Material Group Co., Ltd. (SHSE:603055) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Zhejiang Taihua New Material Group

What Is Zhejiang Taihua New Material Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Zhejiang Taihua New Material Group had CN¥4.30b of debt, an increase on CN¥2.76b, over one year. However, it also had CN¥877.2m in cash, and so its net debt is CN¥3.42b.

How Healthy Is Zhejiang Taihua New Material Group's Balance Sheet?

The latest balance sheet data shows that Zhejiang Taihua New Material Group had liabilities of CN¥4.19b due within a year, and liabilities of CN¥2.38b falling due after that. On the other hand, it had cash of CN¥877.2m and CN¥1.62b worth of receivables due within a year. So its liabilities total CN¥4.08b more than the combination of its cash and short-term receivables.

Zhejiang Taihua New Material Group has a market capitalization of CN¥9.62b, so it could very likely raise cash to ameliorate 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.

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 Taihua New Material Group has a debt to EBITDA ratio of 3.3 and its EBIT covered its interest expense 6.2 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably, Zhejiang Taihua New Material Group's EBIT launched higher than Elon Musk, gaining a whopping 193% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Zhejiang Taihua New Material Group 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Zhejiang Taihua New Material Group 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

Neither Zhejiang Taihua New Material Group's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. We think that Zhejiang Taihua New Material Group's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example Zhejiang Taihua New Material Group has 3 warning signs (and 2 which are significant) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.