China Animal Husbandry Industry (SHSE:600195) Has A Somewhat Strained Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 China Animal Husbandry Industry Co., Ltd. (SHSE:600195) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. 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.

View our latest analysis for China Animal Husbandry Industry

What Is China Animal Husbandry Industry's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 China Animal Husbandry Industry had CN¥1.34b of debt, an increase on CN¥1.06b, over one year. However, it does have CN¥622.0m in cash offsetting this, leading to net debt of about CN¥720.8m.

A Look At China Animal Husbandry Industry's Liabilities

Zooming in on the latest balance sheet data, we can see that China Animal Husbandry Industry had liabilities of CN¥1.78b due within 12 months and liabilities of CN¥711.6m due beyond that. Offsetting this, it had CN¥622.0m in cash and CN¥1.92b in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to China Animal Husbandry Industry's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥7.68b 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that China Animal Husbandry Industry's moderate net debt to EBITDA ratio ( being 2.2), indicates prudence when it comes to debt. And its commanding EBIT of 1k times its interest expense, implies the debt load is as light as a peacock feather. Shareholders should be aware that China Animal Husbandry Industry's EBIT was down 98% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China Animal Husbandry Industry's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, China Animal Husbandry Industry 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

Neither China Animal Husbandry Industry's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. When we consider all the factors discussed, it seems to us that China Animal Husbandry Industry is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with China Animal Husbandry Industry (including 1 which is significant) .

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.