Is Hubei DinglongLtd (SZSE:300054) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Hubei Dinglong CO.,Ltd. (SZSE:300054) does use debt in its business. But the more important question is: how much risk is that debt creating?

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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 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 examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Hubei DinglongLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Hubei DinglongLtd had debt of CN¥1.35b, up from CN¥897.8m in one year. However, it also had CN¥1.10b in cash, and so its net debt is CN¥253.1m.

How Strong Is Hubei DinglongLtd's Balance Sheet?

The latest balance sheet data shows that Hubei DinglongLtd had liabilities of CN¥1.35b due within a year, and liabilities of CN¥1.16b falling due after that. Offsetting these obligations, it had cash of CN¥1.10b as well as receivables valued at CN¥1.09b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥324.5m.

This state of affairs indicates that Hubei DinglongLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥25.7b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, Hubei DinglongLtd has virtually no net debt, so it's fair to say it does not have a heavy debt load!

Check out our latest analysis for Hubei DinglongLtd

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.

Hubei DinglongLtd's net debt is only 0.35 times its EBITDA. And its EBIT covers its interest expense a whopping 22.7 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Hubei DinglongLtd has boosted its EBIT by 98%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hubei DinglongLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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, Hubei DinglongLtd 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

Happily, Hubei DinglongLtd's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. When we consider the range of factors above, it looks like Hubei DinglongLtd is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. Over time, share prices tend to follow earnings per share, so if you're interested in Hubei DinglongLtd, 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.