We Think Henan Zhongfu IndustrialLtd (SHSE:600595) Can Stay On Top Of Its Debt

Warren Buffett famously said, '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. As with many other companies Henan Zhongfu Industrial Co.,Ltd (SHSE:600595) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

See our latest analysis for Henan Zhongfu IndustrialLtd

What Is Henan Zhongfu IndustrialLtd's Debt?

As you can see below, Henan Zhongfu IndustrialLtd had CN¥4.30b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥807.7m in cash, and so its net debt is CN¥3.49b.

A Look At Henan Zhongfu IndustrialLtd's Liabilities

The latest balance sheet data shows that Henan Zhongfu IndustrialLtd had liabilities of CN¥4.87b due within a year, and liabilities of CN¥3.35b falling due after that. On the other hand, it had cash of CN¥807.7m and CN¥1.78b worth of receivables due within a year. So its liabilities total CN¥5.64b more than the combination of its cash and short-term receivables.

Henan Zhongfu IndustrialLtd has a market capitalization of CN¥11.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

While Henan Zhongfu IndustrialLtd's low debt to EBITDA ratio of 1.4 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.2 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. On top of that, Henan Zhongfu IndustrialLtd grew its EBIT by 35% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Henan Zhongfu IndustrialLtd 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 most recent three years, Henan Zhongfu IndustrialLtd recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Henan Zhongfu IndustrialLtd's impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Taking all this data into account, it seems to us that Henan Zhongfu IndustrialLtd takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. Over time, share prices tend to follow earnings per share, so if you're interested in Henan Zhongfu IndustrialLtd, you may well want to click here to check an interactive graph of its earnings per share history.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.