ZYF Lopsking Aluminum (SZSE:002333) Has A Pretty Healthy Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, ZYF Lopsking Aluminum Co., Ltd. (SZSE:002333) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for ZYF Lopsking Aluminum

What Is ZYF Lopsking Aluminum's Debt?

As you can see below, at the end of March 2024, ZYF Lopsking Aluminum had CN¥565.1m of debt, up from CN¥406.3m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥541.8m, its net debt is less, at about CN¥23.2m.

How Healthy Is ZYF Lopsking Aluminum's Balance Sheet?

We can see from the most recent balance sheet that ZYF Lopsking Aluminum had liabilities of CN¥1.08b falling due within a year, and liabilities of CN¥163.5m due beyond that. On the other hand, it had cash of CN¥541.8m and CN¥1.18b worth of receivables due within a year. So it actually has CN¥473.7m more liquid assets than total liabilities.

This short term liquidity is a sign that ZYF Lopsking Aluminum could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, ZYF Lopsking Aluminum has a very light debt load indeed.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

ZYF Lopsking Aluminum's net debt is only 0.16 times its EBITDA. And its EBIT easily covers its interest expense, being 14.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Although ZYF Lopsking Aluminum made a loss at the EBIT level, last year, it was also good to see that it generated CN¥61m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is ZYF Lopsking Aluminum'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.

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 the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, ZYF Lopsking Aluminum burned a lot of cash. 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

ZYF Lopsking Aluminum's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that ZYF Lopsking Aluminum is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of ZYF Lopsking Aluminum's earnings per share history for free.

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.