Does Ningbo Changhong Polymer Scientific and Technical (SHSE:605008) Have A Healthy Balance Sheet?

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. As with many other companies Ningbo Changhong Polymer Scientific and Technical Inc. (SHSE:605008) makes use of debt. But the more important question is: how much risk is that debt creating?

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 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ningbo Changhong Polymer Scientific and Technical

What Is Ningbo Changhong Polymer Scientific and Technical's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Ningbo Changhong Polymer Scientific and Technical had debt of CN¥2.45b, up from CN¥1.70b in one year. However, it also had CN¥445.5m in cash, and so its net debt is CN¥2.00b.

A Look At Ningbo Changhong Polymer Scientific and Technical's Liabilities

We can see from the most recent balance sheet that Ningbo Changhong Polymer Scientific and Technical had liabilities of CN¥2.21b falling due within a year, and liabilities of CN¥786.2m due beyond that. On the other hand, it had cash of CN¥445.5m and CN¥462.3m worth of receivables due within a year. So its liabilities total CN¥2.09b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Ningbo Changhong Polymer Scientific and Technical has a market capitalization of CN¥8.20b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.62 times and a disturbingly high net debt to EBITDA ratio of 10.8 hit our confidence in Ningbo Changhong Polymer Scientific and Technical like a one-two punch to the gut. The debt burden here is substantial. Worse, Ningbo Changhong Polymer Scientific and Technical's EBIT was down 61% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Ningbo Changhong Polymer Scientific and Technical can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Ningbo Changhong Polymer Scientific and Technical 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

To be frank both Ningbo Changhong Polymer Scientific and Technical's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to handle its total liabilities isn't such a worry. We're quite clear that we consider Ningbo Changhong Polymer Scientific and Technical to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Ningbo Changhong Polymer Scientific and Technical (of which 2 make us uncomfortable!) you should know about.

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.