Here's Why Zhejiang Fulai New MaterialLtd (SHSE:605488) Has A Meaningful Debt Burden

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Zhejiang Fulai New Material Co.,Ltd. (SHSE:605488) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Zhejiang Fulai New MaterialLtd

What Is Zhejiang Fulai New MaterialLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhejiang Fulai New MaterialLtd had CN¥1.24b of debt, an increase on CN¥926.4m, over one year. However, it does have CN¥434.8m in cash offsetting this, leading to net debt of about CN¥809.0m.

How Strong Is Zhejiang Fulai New MaterialLtd's Balance Sheet?

According to the last reported balance sheet, Zhejiang Fulai New MaterialLtd had liabilities of CN¥1.41b due within 12 months, and liabilities of CN¥633.5m due beyond 12 months. On the other hand, it had cash of CN¥434.8m and CN¥574.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.03b.

This deficit isn't so bad because Zhejiang Fulai New MaterialLtd is worth CN¥4.04b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

With a net debt to EBITDA ratio of 6.9, it's fair to say Zhejiang Fulai New MaterialLtd does have a significant amount of debt. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. On the other hand, Zhejiang Fulai New MaterialLtd grew its EBIT by 26% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Zhejiang Fulai New MaterialLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. During the last three years, Zhejiang Fulai New MaterialLtd 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

Both Zhejiang Fulai New MaterialLtd's conversion of EBIT to free cash flow and its net debt to EBITDA were discouraging. But at least its EBIT growth rate is a gleaming silver lining to those clouds. Taking the abovementioned factors together we do think Zhejiang Fulai New MaterialLtd's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 5 warning signs we've spotted with Zhejiang Fulai New MaterialLtd (including 3 which are concerning) .

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.

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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.