We Think Zhongfu Shenying Carbon FiberLtd (SHSE:688295) Is Taking Some Risk With Its Debt

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Zhongfu Shenying Carbon Fiber Co.,Ltd. (SHSE:688295) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Zhongfu Shenying Carbon FiberLtd

What Is Zhongfu Shenying Carbon FiberLtd's Net Debt?

As you can see below, at the end of March 2024, Zhongfu Shenying Carbon FiberLtd had CN¥2.58b of debt, up from CN¥1.40b a year ago. Click the image for more detail. However, it also had CN¥2.31b in cash, and so its net debt is CN¥271.2m.

A Look At Zhongfu Shenying Carbon FiberLtd's Liabilities

We can see from the most recent balance sheet that Zhongfu Shenying Carbon FiberLtd had liabilities of CN¥1.95b falling due within a year, and liabilities of CN¥2.96b due beyond that. Offsetting these obligations, it had cash of CN¥2.31b as well as receivables valued at CN¥917.6m due within 12 months. So it has liabilities totalling CN¥1.68b more than its cash and near-term receivables, combined.

Given Zhongfu Shenying Carbon FiberLtd has a market capitalization of CN¥18.1b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Zhongfu Shenying Carbon FiberLtd's net debt is only 0.72 times its EBITDA. And its EBIT easily covers its interest expense, being 44.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for Zhongfu Shenying Carbon FiberLtd if management cannot prevent a repeat of the 82% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zhongfu Shenying Carbon FiberLtd 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Zhongfu Shenying Carbon FiberLtd burned a lot of cash. 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

Zhongfu Shenying Carbon FiberLtd's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Zhongfu Shenying Carbon FiberLtd'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. 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 example, we've discovered 2 warning signs for Zhongfu Shenying Carbon FiberLtd (1 is significant!) that you should be aware of before investing here.

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.

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