These 4 Measures Indicate That Xiangtan Electrochemical ScientificLtd (SZSE:002125) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We note that Xiangtan Electrochemical Scientific Co.,Ltd (SZSE:002125) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Xiangtan Electrochemical ScientificLtd

What Is Xiangtan Electrochemical ScientificLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Xiangtan Electrochemical ScientificLtd had debt of CN¥1.41b at the end of March 2024, a reduction from CN¥1.75b over a year. On the flip side, it has CN¥313.0m in cash leading to net debt of about CN¥1.10b.

How Healthy Is Xiangtan Electrochemical ScientificLtd's Balance Sheet?

The latest balance sheet data shows that Xiangtan Electrochemical ScientificLtd had liabilities of CN¥1.06b due within a year, and liabilities of CN¥924.7m falling due after that. On the other hand, it had cash of CN¥313.0m and CN¥654.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.01b.

Given Xiangtan Electrochemical ScientificLtd has a market capitalization of CN¥8.12b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

We'd say that Xiangtan Electrochemical ScientificLtd's moderate net debt to EBITDA ratio ( being 2.1), indicates prudence when it comes to debt. And its strong interest cover of 1k times, makes us even more comfortable. Notably, Xiangtan Electrochemical ScientificLtd's EBIT launched higher than Elon Musk, gaining a whopping 128% on last year. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Xiangtan Electrochemical ScientificLtd 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Xiangtan Electrochemical ScientificLtd recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Xiangtan Electrochemical ScientificLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that Xiangtan Electrochemical ScientificLtd takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. We've identified 1 warning sign with Xiangtan Electrochemical ScientificLtd , 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.