These 4 Measures Indicate That Henan Rebecca Hair Products (SHSE:600439) Is Using Debt Reasonably Well

Warren Buffett famously said, '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 Henan Rebecca Hair Products Co., Ltd. (SHSE:600439) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Henan Rebecca Hair Products

What Is Henan Rebecca Hair Products's Net Debt?

As you can see below, at the end of September 2024, Henan Rebecca Hair Products had CN¥2.29b of debt, up from CN¥2.18b a year ago. Click the image for more detail. However, it also had CN¥791.0m in cash, and so its net debt is CN¥1.50b.

A Look At Henan Rebecca Hair Products' Liabilities

According to the last reported balance sheet, Henan Rebecca Hair Products had liabilities of CN¥2.38b due within 12 months, and liabilities of CN¥34.9m due beyond 12 months. Offsetting this, it had CN¥791.0m in cash and CN¥319.6m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.31b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Henan Rebecca Hair Products is worth CN¥4.06b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Henan Rebecca Hair Products shareholders face the double whammy of a high net debt to EBITDA ratio (10.6), and fairly weak interest coverage, since EBIT is just 1.1 times the interest expense. The debt burden here is substantial. However, one redeeming factor is that Henan Rebecca Hair Products grew its EBIT at 16% over the last 12 months, boosting its ability to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Henan Rebecca Hair Products will need earnings to service that debt. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Henan Rebecca Hair Products actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We weren't impressed with Henan Rebecca Hair Products's net debt to EBITDA, and its interest cover made us cautious. But its conversion of EBIT to free cash flow was significantly redeeming. Looking at all this data makes us feel a little cautious about Henan Rebecca Hair Products's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. We've identified 4 warning signs with Henan Rebecca Hair Products (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.