Here's Why Zhe Jiang Hai Liang (SZSE:002203) Has A Meaningful Debt Burden

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. Importantly, Zhe Jiang Hai Liang Co., Ltd (SZSE:002203) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Zhe Jiang Hai Liang

What Is Zhe Jiang Hai Liang's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Zhe Jiang Hai Liang had CN¥20.9b of debt, an increase on CN¥18.6b, over one year. However, it also had CN¥6.79b in cash, and so its net debt is CN¥14.1b.

How Healthy Is Zhe Jiang Hai Liang's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zhe Jiang Hai Liang had liabilities of CN¥18.5b due within 12 months and liabilities of CN¥8.36b due beyond that. On the other hand, it had cash of CN¥6.79b and CN¥8.31b worth of receivables due within a year. So its liabilities total CN¥11.8b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥16.0b, so it does suggest shareholders should keep an eye on Zhe Jiang Hai Liang's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Zhe Jiang Hai Liang has a rather high debt to EBITDA ratio of 6.0 which suggests a meaningful debt load. However, its interest coverage of 6.5 is reasonably strong, which is a good sign. We saw Zhe Jiang Hai Liang grow its EBIT by 10.0% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhe Jiang Hai Liang 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Zhe Jiang Hai Liang burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Zhe Jiang Hai Liang's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, we think it's fair to say that Zhe Jiang Hai Liang has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Zhe Jiang Hai Liang (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.