Henan Zhongfu IndustrialLtd (SHSE:600595) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Henan Zhongfu Industrial Co.,Ltd (SHSE:600595) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Henan Zhongfu IndustrialLtd

What Is Henan Zhongfu IndustrialLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Henan Zhongfu IndustrialLtd had CN¥2.82b of debt in June 2024, down from CN¥4.03b, one year before. On the flip side, it has CN¥1.21b in cash leading to net debt of about CN¥1.61b.

How Strong Is Henan Zhongfu IndustrialLtd's Balance Sheet?

According to the last reported balance sheet, Henan Zhongfu IndustrialLtd had liabilities of CN¥4.95b due within 12 months, and liabilities of CN¥3.54b due beyond 12 months. On the other hand, it had cash of CN¥1.21b and CN¥2.08b worth of receivables due within a year. So it has liabilities totalling CN¥5.20b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Henan Zhongfu IndustrialLtd has a market capitalization of CN¥9.54b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Henan Zhongfu IndustrialLtd's net debt is only 0.61 times its EBITDA. And its EBIT easily covers its interest expense, being 16.0 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, Henan Zhongfu IndustrialLtd grew its EBIT by 114% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Henan Zhongfu IndustrialLtd'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Henan Zhongfu IndustrialLtd produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Henan Zhongfu IndustrialLtd'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 truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at the bigger picture, we think Henan Zhongfu IndustrialLtd's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Henan Zhongfu IndustrialLtd's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.