Is Cangzhou Dahua (SHSE:600230) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Cangzhou Dahua Co., Ltd. (SHSE:600230) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Cangzhou Dahua

How Much Debt Does Cangzhou Dahua Carry?

The image below, which you can click on for greater detail, shows that Cangzhou Dahua had debt of CN¥357.2m at the end of September 2024, a reduction from CN¥1.12b over a year. However, it does have CN¥283.7m in cash offsetting this, leading to net debt of about CN¥73.5m.

A Look At Cangzhou Dahua's Liabilities

Zooming in on the latest balance sheet data, we can see that Cangzhou Dahua had liabilities of CN¥1.21b due within 12 months and liabilities of CN¥418.4m due beyond that. Offsetting these obligations, it had cash of CN¥283.7m as well as receivables valued at CN¥245.9m due within 12 months. So it has liabilities totalling CN¥1.10b more than its cash and near-term receivables, combined.

Cangzhou Dahua has a market capitalization of CN¥4.16b, so it could very likely raise cash to ameliorate 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.

Given net debt is only 0.13 times EBITDA, it is initially surprising to see that Cangzhou Dahua's EBIT has low interest coverage of 1.3 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, Cangzhou Dahua's EBIT fell a jaw-dropping 96% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is Cangzhou Dahua'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 we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Cangzhou Dahua actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Cangzhou Dahua's EBIT growth rate was a real negative on this analysis, as was its interest cover. But like a ballerina ending on a perfect pirouette, it has not trouble converting EBIT to free cash flow. Looking at all this data makes us feel a little cautious about Cangzhou Dahua's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Case in point: We've spotted 3 warning signs for Cangzhou Dahua you should be aware of.

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.