Is Wanhua Chemical Group (SHSE:600309) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Wanhua Chemical Group Co., Ltd. (SHSE:600309) does carry debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Wanhua Chemical Group

What Is Wanhua Chemical Group's Debt?

The chart below, which you can click on for greater detail, shows that Wanhua Chemical Group had CN¥121.1b in debt in September 2024; about the same as the year before. However, it does have CN¥41.2b in cash offsetting this, leading to net debt of about CN¥79.9b.

How Healthy Is Wanhua Chemical Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wanhua Chemical Group had liabilities of CN¥139.4b due within 12 months and liabilities of CN¥68.7b due beyond that. Offsetting these obligations, it had cash of CN¥41.2b as well as receivables valued at CN¥18.1b due within 12 months. So it has liabilities totalling CN¥148.7b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Wanhua Chemical Group is worth a massive CN¥250.9b, and thus could probably raise enough capital to shore up 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.

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.

Wanhua Chemical Group's net debt is 2.5 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 16.4 is very high, suggesting that the interest expense on the debt is currently quite low. Wanhua Chemical Group grew its EBIT by 2.4% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Wanhua Chemical Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Wanhua Chemical Group saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Neither Wanhua Chemical Group's ability to convert EBIT to free cash flow nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. When we consider all the factors discussed, it seems to us that Wanhua Chemical Group is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Wanhua Chemical Group is showing 2 warning signs in our investment analysis , you should know about...

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.