Is Ningbo Changhong Polymer Scientific and Technical (SHSE:605008) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Ningbo Changhong Polymer Scientific and Technical Inc. (SHSE:605008) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ningbo Changhong Polymer Scientific and Technical

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

The image below, which you can click on for greater detail, shows that at March 2024 Ningbo Changhong Polymer Scientific and Technical had debt of CN¥2.13b, up from CN¥1.40b in one year. On the flip side, it has CN¥308.7m in cash leading to net debt of about CN¥1.82b.

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¥1.68b falling due within a year, and liabilities of CN¥974.7m due beyond that. On the other hand, it had cash of CN¥308.7m and CN¥528.9m worth of receivables due within a year. So its liabilities total CN¥1.82b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Ningbo Changhong Polymer Scientific and Technical is worth CN¥8.32b, and thus could probably raise enough capital to shore up 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.

Weak interest cover of 0.21 times and a disturbingly high net debt to EBITDA ratio of 12.2 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 94% 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Ningbo Changhong Polymer Scientific and Technical burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Ningbo Changhong Polymer Scientific and Technical you should be aware of, and 2 of them are potentially serious.

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.

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