Hangzhou Oxygen Plant GroupLtd (SZSE:002430) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, Hangzhou Oxygen Plant Group Co.,Ltd. (SZSE:002430) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for Hangzhou Oxygen Plant GroupLtd

What Is Hangzhou Oxygen Plant GroupLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Hangzhou Oxygen Plant GroupLtd had CN¥6.90b of debt, an increase on CN¥5.49b, over one year. On the flip side, it has CN¥2.98b in cash leading to net debt of about CN¥3.92b.

How Strong Is Hangzhou Oxygen Plant GroupLtd's Balance Sheet?

The latest balance sheet data shows that Hangzhou Oxygen Plant GroupLtd had liabilities of CN¥9.29b due within a year, and liabilities of CN¥4.54b falling due after that. On the other hand, it had cash of CN¥2.98b and CN¥4.30b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.55b.

While this might seem like a lot, it is not so bad since Hangzhou Oxygen Plant GroupLtd has a market capitalization of CN¥20.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Hangzhou Oxygen Plant GroupLtd's net debt to EBITDA ratio of about 1.7 suggests only moderate use of debt. And its commanding EBIT of 17.5 times its interest expense, implies the debt load is as light as a peacock feather. Also positive, Hangzhou Oxygen Plant GroupLtd grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hangzhou Oxygen Plant GroupLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Hangzhou Oxygen Plant GroupLtd 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

Based on what we've seen Hangzhou Oxygen Plant GroupLtd is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Hangzhou Oxygen Plant GroupLtd's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. Over time, share prices tend to follow earnings per share, so if you're interested in Hangzhou Oxygen Plant GroupLtd, you may well want to click here to check an interactive graph of its earnings per share history.

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.