Is Zhejiang Qianjiang Biochemical (SHSE:600796) A Risky Investment?

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.' 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. Importantly, Zhejiang Qianjiang Biochemical Co., Ltd (SHSE:600796) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Zhejiang Qianjiang Biochemical

How Much Debt Does Zhejiang Qianjiang Biochemical Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhejiang Qianjiang Biochemical had CN¥2.42b of debt, an increase on CN¥2.01b, over one year. However, it also had CN¥910.2m in cash, and so its net debt is CN¥1.51b.

How Strong Is Zhejiang Qianjiang Biochemical's Balance Sheet?

The latest balance sheet data shows that Zhejiang Qianjiang Biochemical had liabilities of CN¥1.81b due within a year, and liabilities of CN¥2.17b falling due after that. Offsetting these obligations, it had cash of CN¥910.2m as well as receivables valued at CN¥1.31b due within 12 months. So it has liabilities totalling CN¥1.75b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Zhejiang Qianjiang Biochemical has a market capitalization of CN¥4.71b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt to EBITDA of 3.3 Zhejiang Qianjiang Biochemical has a fairly noticeable amount of debt. But the high interest coverage of 9.6 suggests it can easily service that debt. Unfortunately, Zhejiang Qianjiang Biochemical saw its EBIT slide 3.5% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Zhejiang Qianjiang Biochemical will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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, Zhejiang Qianjiang Biochemical saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We'd go so far as to say Zhejiang Qianjiang Biochemical's conversion of EBIT to free cash flow was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Zhejiang Qianjiang Biochemical stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Zhejiang Qianjiang Biochemical 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.

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.