Here's Why Yunnan Chihong Zinc & Germanium (SHSE:600497) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Yunnan Chihong Zinc & Germanium Co., Ltd. (SHSE:600497) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Yunnan Chihong Zinc & Germanium

What Is Yunnan Chihong Zinc & Germanium's Debt?

You can click the graphic below for the historical numbers, but it shows that Yunnan Chihong Zinc & Germanium had CN¥3.82b of debt in September 2024, down from CN¥4.21b, one year before. However, because it has a cash reserve of CN¥1.34b, its net debt is less, at about CN¥2.48b.

How Strong Is Yunnan Chihong Zinc & Germanium's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yunnan Chihong Zinc & Germanium had liabilities of CN¥5.15b due within 12 months and liabilities of CN¥2.49b due beyond that. On the other hand, it had cash of CN¥1.34b and CN¥357.1m worth of receivables due within a year. So its liabilities total CN¥5.95b more than the combination of its cash and short-term receivables.

Since publicly traded Yunnan Chihong Zinc & Germanium shares are worth a total of CN¥31.2b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Yunnan Chihong Zinc & Germanium's net debt is only 0.85 times its EBITDA. And its EBIT covers its interest expense a whopping 23.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for Yunnan Chihong Zinc & Germanium if management cannot prevent a repeat of the 30% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Yunnan Chihong Zinc & Germanium can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Yunnan Chihong Zinc & Germanium actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Yunnan Chihong Zinc & Germanium's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its EBIT growth rate. All these things considered, it appears that Yunnan Chihong Zinc & Germanium can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Yunnan Chihong Zinc & Germanium that you should be aware of before investing here.

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.