Here's Why Jiangsu ChengXing Phosph-Chemicals (SHSE:600078) Has A Meaningful Debt Burden

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 can see that Jiangsu ChengXing Phosph-Chemicals Co., Ltd. (SHSE:600078) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Jiangsu ChengXing Phosph-Chemicals

What Is Jiangsu ChengXing Phosph-Chemicals's Net Debt?

As you can see below, Jiangsu ChengXing Phosph-Chemicals had CN¥1.70b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥506.3m in cash, and so its net debt is CN¥1.20b.

How Healthy Is Jiangsu ChengXing Phosph-Chemicals' Balance Sheet?

The latest balance sheet data shows that Jiangsu ChengXing Phosph-Chemicals had liabilities of CN¥1.47b due within a year, and liabilities of CN¥1.56b falling due after that. On the other hand, it had cash of CN¥506.3m and CN¥934.3m worth of receivables due within a year. So its liabilities total CN¥1.59b more than the combination of its cash and short-term receivables.

Jiangsu ChengXing Phosph-Chemicals has a market capitalization of CN¥3.81b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Jiangsu ChengXing Phosph-Chemicals's debt is 3.3 times its EBITDA, and its EBIT cover its interest expense 5.0 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, Jiangsu ChengXing Phosph-Chemicals's EBIT fell a jaw-dropping 54% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is Jiangsu ChengXing Phosph-Chemicals'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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Jiangsu ChengXing Phosph-Chemicals generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Neither Jiangsu ChengXing Phosph-Chemicals's ability to grow its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Looking at all the angles mentioned above, it does seem to us that Jiangsu ChengXing Phosph-Chemicals is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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 - Jiangsu ChengXing Phosph-Chemicals has 1 warning sign we think you should be aware of.

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.