Is Xinxiang Chemical Fiber (SZSE:000949) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Xinxiang Chemical Fiber Co., Ltd. (SZSE:000949) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Xinxiang Chemical Fiber

What Is Xinxiang Chemical Fiber's Net Debt?

As you can see below, at the end of September 2024, Xinxiang Chemical Fiber had CN¥4.72b of debt, up from CN¥4.45b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥1.76b, its net debt is less, at about CN¥2.95b.

How Strong Is Xinxiang Chemical Fiber's Balance Sheet?

The latest balance sheet data shows that Xinxiang Chemical Fiber had liabilities of CN¥3.84b due within a year, and liabilities of CN¥2.93b falling due after that. Offsetting this, it had CN¥1.76b in cash and CN¥1.49b in receivables that were due within 12 months. So it has liabilities totalling CN¥3.52b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Xinxiang Chemical Fiber is worth CN¥6.25b, 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.

Xinxiang Chemical Fiber has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 2.8 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. One redeeming factor for Xinxiang Chemical Fiber is that it turned last year's EBIT loss into a gain of CN¥360m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Xinxiang Chemical Fiber'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Xinxiang Chemical Fiber saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over Xinxiang Chemical Fiber's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. Having said that, its ability to grow its EBIT isn't such a worry. Overall, we think it's fair to say that Xinxiang Chemical Fiber has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. For example Xinxiang Chemical Fiber has 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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.