We Think ShenZhen YUTO Packaging Technology (SZSE:002831) Can Manage Its Debt With Ease

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.' 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. We can see that ShenZhen YUTO Packaging Technology Co., Ltd. (SZSE:002831) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 ShenZhen YUTO Packaging Technology

How Much Debt Does ShenZhen YUTO Packaging Technology Carry?

The chart below, which you can click on for greater detail, shows that ShenZhen YUTO Packaging Technology had CN¥5.42b in debt in September 2024; about the same as the year before. However, it also had CN¥4.26b in cash, and so its net debt is CN¥1.16b.

How Strong Is ShenZhen YUTO Packaging Technology's Balance Sheet?

The latest balance sheet data shows that ShenZhen YUTO Packaging Technology had liabilities of CN¥9.64b due within a year, and liabilities of CN¥1.37b falling due after that. On the other hand, it had cash of CN¥4.26b and CN¥6.09b worth of receivables due within a year. So it has liabilities totalling CN¥665.3m more than its cash and near-term receivables, combined.

Of course, ShenZhen YUTO Packaging Technology has a market capitalization of CN¥23.9b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

ShenZhen YUTO Packaging Technology has a low net debt to EBITDA ratio of only 0.45. And its EBIT easily covers its interest expense, being 31.0 times the size. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that ShenZhen YUTO Packaging Technology grew its EBIT by 12% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine ShenZhen YUTO Packaging Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the most recent three years, ShenZhen YUTO Packaging Technology recorded free cash flow worth 80% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that ShenZhen YUTO Packaging Technology's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Overall, we don't think ShenZhen YUTO Packaging Technology is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. 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. For example - ShenZhen YUTO Packaging Technology has 1 warning sign we think you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.