We Think Qingdao Kingking Applied Chemistry (SZSE:002094) Is Taking Some Risk With 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. Importantly, Qingdao Kingking Applied Chemistry Co., Ltd. (SZSE:002094) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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

See our latest analysis for Qingdao Kingking Applied Chemistry

How Much Debt Does Qingdao Kingking Applied Chemistry Carry?

As you can see below, Qingdao Kingking Applied Chemistry had CN¥1.17b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥665.9m in cash, and so its net debt is CN¥501.0m.

How Strong Is Qingdao Kingking Applied Chemistry's Balance Sheet?

The latest balance sheet data shows that Qingdao Kingking Applied Chemistry had liabilities of CN¥1.94b due within a year, and liabilities of CN¥8.71m falling due after that. Offsetting these obligations, it had cash of CN¥665.9m as well as receivables valued at CN¥588.0m due within 12 months. So it has liabilities totalling CN¥690.7m more than its cash and near-term receivables, combined.

Since publicly traded Qingdao Kingking Applied Chemistry shares are worth a total of CN¥4.64b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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

Qingdao Kingking Applied Chemistry's net debt is 4.7 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 1k times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Notably, Qingdao Kingking Applied Chemistry made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥82m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Qingdao Kingking Applied Chemistry will need earnings to service that debt. 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 is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Qingdao Kingking Applied Chemistry 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

Qingdao Kingking Applied Chemistry's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Qingdao Kingking Applied Chemistry is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Qingdao Kingking Applied Chemistry you should know about.

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.