Here's Why Lizhong Sitong Light Alloys Group (SZSE:300428) Has A Meaningful Debt Burden

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.' 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. As with many other companies Lizhong Sitong Light Alloys Group Co., Ltd. (SZSE:300428) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Lizhong Sitong Light Alloys Group

How Much Debt Does Lizhong Sitong Light Alloys Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Lizhong Sitong Light Alloys Group had CN¥9.76b of debt, an increase on CN¥8.64b, over one year. However, it does have CN¥3.54b in cash offsetting this, leading to net debt of about CN¥6.22b.

How Healthy Is Lizhong Sitong Light Alloys Group's Balance Sheet?

The latest balance sheet data shows that Lizhong Sitong Light Alloys Group had liabilities of CN¥8.84b due within a year, and liabilities of CN¥3.50b falling due after that. Offsetting these obligations, it had cash of CN¥3.54b as well as receivables valued at CN¥5.78b due within 12 months. So its liabilities total CN¥3.03b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Lizhong Sitong Light Alloys Group has a market capitalization of CN¥11.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Lizhong Sitong Light Alloys Group has a rather high debt to EBITDA ratio of 5.8 which suggests a meaningful debt load. However, its interest coverage of 2.7 is reasonably strong, which is a good sign. On a slightly more positive note, Lizhong Sitong Light Alloys Group grew its EBIT at 15% over the last year, further increasing its ability to manage debt. 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 Lizhong Sitong Light Alloys Group 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Lizhong Sitong Light Alloys Group 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

On the face of it, Lizhong Sitong Light Alloys Group's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Lizhong Sitong Light Alloys Group's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Lizhong Sitong Light Alloys Group is showing 1 warning sign in our investment analysis , you should know about...

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.