Here's Why Zhejiang Yonghe Refrigerant (SHSE:605020) Is Weighed Down By Its Debt Load

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.' 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. We note that Zhejiang Yonghe Refrigerant Co., Ltd. (SHSE:605020) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Zhejiang Yonghe Refrigerant

What Is Zhejiang Yonghe Refrigerant's Debt?

As you can see below, at the end of March 2024, Zhejiang Yonghe Refrigerant had CN¥2.51b of debt, up from CN¥1.74b a year ago. Click the image for more detail. On the flip side, it has CN¥259.5m in cash leading to net debt of about CN¥2.25b.

How Strong Is Zhejiang Yonghe Refrigerant's Balance Sheet?

According to the last reported balance sheet, Zhejiang Yonghe Refrigerant had liabilities of CN¥2.79b due within 12 months, and liabilities of CN¥1.56b due beyond 12 months. Offsetting these obligations, it had cash of CN¥259.5m as well as receivables valued at CN¥645.1m due within 12 months. So it has liabilities totalling CN¥3.44b more than its cash and near-term receivables, combined.

Zhejiang Yonghe Refrigerant has a market capitalization of CN¥5.95b, 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Zhejiang Yonghe Refrigerant's debt is 4.9 times its EBITDA, and its EBIT cover its interest expense 2.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Worse, Zhejiang Yonghe Refrigerant's EBIT was down 43% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhejiang Yonghe Refrigerant'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Zhejiang Yonghe Refrigerant 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

On the face of it, Zhejiang Yonghe Refrigerant's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. After considering the datapoints discussed, we think Zhejiang Yonghe Refrigerant has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. For instance, we've identified 4 warning signs for Zhejiang Yonghe Refrigerant (2 are a bit unpleasant) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.