Is Xinjiang Zhongtai Chemical (SZSE:002092) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Xinjiang Zhongtai Chemical Co., Ltd. (SZSE:002092) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Xinjiang Zhongtai Chemical

How Much Debt Does Xinjiang Zhongtai Chemical Carry?

As you can see below, at the end of June 2024, Xinjiang Zhongtai Chemical had CN¥22.6b of debt, up from CN¥21.4b a year ago. Click the image for more detail. However, it also had CN¥5.33b in cash, and so its net debt is CN¥17.3b.

How Healthy Is Xinjiang Zhongtai Chemical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Xinjiang Zhongtai Chemical had liabilities of CN¥31.0b due within 12 months and liabilities of CN¥13.3b due beyond that. On the other hand, it had cash of CN¥5.33b and CN¥5.50b worth of receivables due within a year. So its liabilities total CN¥33.6b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥9.38b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Xinjiang Zhongtai Chemical would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is Xinjiang Zhongtai Chemical's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Xinjiang Zhongtai Chemical made a loss at the EBIT level, and saw its revenue drop to CN¥32b, which is a fall of 25%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Xinjiang Zhongtai Chemical's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥354m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of CN¥2.2b in the last year. So we think this stock is quite risky. We'd prefer to pass. 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 Xinjiang Zhongtai Chemical (1 is a bit concerning!) that you should be aware of before investing here.

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.