Shandong Weifang Rainbow Chemical (SZSE:301035) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Shandong Weifang Rainbow Chemical Co., Ltd (SZSE:301035) 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?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shandong Weifang Rainbow Chemical

What Is Shandong Weifang Rainbow Chemical's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shandong Weifang Rainbow Chemical had CN¥3.12b of debt, an increase on CN¥699.9m, over one year. However, it does have CN¥2.62b in cash offsetting this, leading to net debt of about CN¥506.1m.

How Strong Is Shandong Weifang Rainbow Chemical's Balance Sheet?

We can see from the most recent balance sheet that Shandong Weifang Rainbow Chemical had liabilities of CN¥7.77b falling due within a year, and liabilities of CN¥183.4m due beyond that. On the other hand, it had cash of CN¥2.62b and CN¥5.22b worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Shandong Weifang Rainbow Chemical's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥11.0b company is short on cash, but still worth keeping an eye on the balance sheet.

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.

Shandong Weifang Rainbow Chemical's net debt is only 0.36 times its EBITDA. And its EBIT easily covers its interest expense, being 32.5 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact Shandong Weifang Rainbow Chemical's saving grace is its low debt levels, because its EBIT has tanked 30% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shandong Weifang Rainbow Chemical 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Shandong Weifang Rainbow Chemical 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

We feel some trepidation about Shandong Weifang Rainbow Chemical's difficulty EBIT growth rate, but we've got positives to focus on, too. For example, its interest cover and net debt to EBITDA give us some confidence in its ability to manage its debt. We think that Shandong Weifang Rainbow Chemical's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Be aware that Shandong Weifang Rainbow Chemical is showing 3 warning signs in our investment analysis , and 1 of those is significant...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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.

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