Tangshan Sanyou Chemical IndustriesLtd (SHSE:600409) Has A Pretty Healthy Balance Sheet

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. We can see that Tangshan Sanyou Chemical Industries Co.,Ltd (SHSE:600409) does use debt in its business. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Tangshan Sanyou Chemical IndustriesLtd

What Is Tangshan Sanyou Chemical IndustriesLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Tangshan Sanyou Chemical IndustriesLtd had debt of CN¥4.71b, up from CN¥3.95b in one year. However, it also had CN¥2.68b in cash, and so its net debt is CN¥2.04b.

A Look At Tangshan Sanyou Chemical IndustriesLtd's Liabilities

We can see from the most recent balance sheet that Tangshan Sanyou Chemical IndustriesLtd had liabilities of CN¥5.34b falling due within a year, and liabilities of CN¥5.14b due beyond that. Offsetting these obligations, it had cash of CN¥2.68b as well as receivables valued at CN¥3.12b due within 12 months. So it has liabilities totalling CN¥4.67b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Tangshan Sanyou Chemical IndustriesLtd is worth CN¥10.9b, 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 use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tangshan Sanyou Chemical IndustriesLtd has a low net debt to EBITDA ratio of only 0.69. And its EBIT easily covers its interest expense, being 11.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Tangshan Sanyou Chemical IndustriesLtd grew its EBIT by 9.2% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Tangshan Sanyou Chemical IndustriesLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Tangshan Sanyou Chemical IndustriesLtd produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Tangshan Sanyou Chemical IndustriesLtd's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its interest cover is also very heartening. When we consider the range of factors above, it looks like Tangshan Sanyou Chemical IndustriesLtd is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. Case in point: We've spotted 1 warning sign for Tangshan Sanyou Chemical IndustriesLtd 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.