Does Chongqing Shunbo AluminumLtd (SZSE:002996) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Chongqing Shunbo Aluminum Co.,Ltd. (SZSE:002996) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Chongqing Shunbo AluminumLtd

What Is Chongqing Shunbo AluminumLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Chongqing Shunbo AluminumLtd had CN¥4.69b of debt, an increase on CN¥3.00b, over one year. However, it does have CN¥1.67b in cash offsetting this, leading to net debt of about CN¥3.02b.

A Look At Chongqing Shunbo AluminumLtd's Liabilities

The latest balance sheet data shows that Chongqing Shunbo AluminumLtd had liabilities of CN¥4.22b due within a year, and liabilities of CN¥1.16b falling due after that. On the other hand, it had cash of CN¥1.67b and CN¥2.96b worth of receivables due within a year. So its liabilities total CN¥758.6m more than the combination of its cash and short-term receivables.

Of course, Chongqing Shunbo AluminumLtd has a market capitalization of CN¥4.19b, 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 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 9.2, it's fair to say Chongqing Shunbo AluminumLtd does have a significant amount of debt. However, its interest coverage of 2.7 is reasonably strong, which is a good sign. Looking on the bright side, Chongqing Shunbo AluminumLtd boosted its EBIT by a silky 72% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Chongqing Shunbo AluminumLtd 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Chongqing Shunbo AluminumLtd saw substantial negative free cash flow, in total. 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

Chongqing Shunbo AluminumLtd's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Chongqing Shunbo AluminumLtd is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Chongqing Shunbo AluminumLtd you should be aware of, and 3 of them make us uncomfortable.

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.