Here's Why Zhuzhou Times New Material Technology (SHSE:600458) Can Manage Its Debt Responsibly

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 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 Zhuzhou Times New Material Technology Co., Ltd. (SHSE:600458) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Zhuzhou Times New Material Technology

What Is Zhuzhou Times New Material Technology's Debt?

As you can see below, at the end of September 2024, Zhuzhou Times New Material Technology had CN¥2.11b of debt, up from CN¥1.73b a year ago. Click the image for more detail. However, it does have CN¥1.62b in cash offsetting this, leading to net debt of about CN¥494.5m.

How Strong Is Zhuzhou Times New Material Technology's Balance Sheet?

According to the last reported balance sheet, Zhuzhou Times New Material Technology had liabilities of CN¥12.1b due within 12 months, and liabilities of CN¥2.09b due beyond 12 months. On the other hand, it had cash of CN¥1.62b and CN¥9.47b worth of receivables due within a year. So it has liabilities totalling CN¥3.08b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Zhuzhou Times New Material Technology has a market capitalization of CN¥10.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Zhuzhou Times New Material Technology has a low net debt to EBITDA ratio of only 0.45. And its EBIT covers its interest expense a whopping 27.6 times over. So we're pretty relaxed about its super-conservative use of debt. Better yet, Zhuzhou Times New Material Technology grew its EBIT by 106% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhuzhou Times New Material Technology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Zhuzhou Times New Material Technology recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Zhuzhou Times New Material Technology's interest cover was a real positive on this analysis, as was its EBIT growth rate. In contrast, our confidence was undermined by its apparent struggle to convert EBIT to free cash flow. Considering this range of data points, we think Zhuzhou Times New Material Technology is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Zhuzhou Times New Material Technology has 1 warning sign we think 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.