Here's Why Yunnan Chihong Zinc & Germanium (SHSE:600497) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Yunnan Chihong Zinc & Germanium Co., Ltd. (SHSE:600497) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Yunnan Chihong Zinc & Germanium

How Much Debt Does Yunnan Chihong Zinc & Germanium Carry?

The image below, which you can click on for greater detail, shows that Yunnan Chihong Zinc & Germanium had debt of CN¥3.82b at the end of September 2024, a reduction from CN¥4.21b over a year. However, it also had CN¥1.34b in cash, and so its net debt is CN¥2.48b.

A Look At Yunnan Chihong Zinc & Germanium's Liabilities

According to the last reported balance sheet, Yunnan Chihong Zinc & Germanium had liabilities of CN¥5.15b due within 12 months, and liabilities of CN¥2.49b due beyond 12 months. On the other hand, it had cash of CN¥1.34b and CN¥357.1m worth of receivables due within a year. So it has liabilities totalling CN¥5.95b more than its cash and near-term receivables, combined.

Given Yunnan Chihong Zinc & Germanium has a market capitalization of CN¥30.1b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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

Yunnan Chihong Zinc & Germanium has a low net debt to EBITDA ratio of only 0.85. 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 a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Yunnan Chihong Zinc & Germanium'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, 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. Over the last three years, Yunnan Chihong Zinc & Germanium actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

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 we must concede we find its EBIT growth rate has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Yunnan Chihong Zinc & Germanium can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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 - Yunnan Chihong Zinc & Germanium has 1 warning sign we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.