Here's Why Huludao Zinc IndustryLtd (SZSE:000751) Is Weighed Down By Its Debt Load

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Huludao Zinc Industry Co.,Ltd. (SZSE:000751) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Huludao Zinc IndustryLtd

How Much Debt Does Huludao Zinc IndustryLtd Carry?

As you can see below, at the end of September 2024, Huludao Zinc IndustryLtd had CN¥2.92b of debt, up from CN¥2.57b a year ago. Click the image for more detail. However, it also had CN¥1.64b in cash, and so its net debt is CN¥1.28b.

A Look At Huludao Zinc IndustryLtd's Liabilities

We can see from the most recent balance sheet that Huludao Zinc IndustryLtd had liabilities of CN¥5.46b falling due within a year, and liabilities of CN¥184.0m due beyond that. Offsetting these obligations, it had cash of CN¥1.64b as well as receivables valued at CN¥460.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.55b.

This deficit is considerable relative to its market capitalization of CN¥4.38b, so it does suggest shareholders should keep an eye on Huludao Zinc IndustryLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

While we wouldn't worry about Huludao Zinc IndustryLtd's net debt to EBITDA ratio of 2.8, we think its super-low interest cover of 1.4 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Worse, Huludao Zinc IndustryLtd's EBIT was down 22% 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 you can't view debt in total isolation; since Huludao Zinc IndustryLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Huludao Zinc IndustryLtd 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, Huludao Zinc IndustryLtd'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 even its level of total liabilities fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like Huludao Zinc IndustryLtd 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. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Huludao Zinc IndustryLtd (at least 2 which don't sit too well with us) , and understanding them should be part of your investment process.

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.