We Think Chongqing Zhifei Biological Products (SZSE:300122) Can Stay On Top Of Its Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Chongqing Zhifei Biological Products Co., Ltd. (SZSE:300122) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Chongqing Zhifei Biological Products

What Is Chongqing Zhifei Biological Products's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Chongqing Zhifei Biological Products had CN¥5.01b of debt, an increase on CN¥4.06b, over one year. On the flip side, it has CN¥2.97b in cash leading to net debt of about CN¥2.04b.

How Healthy Is Chongqing Zhifei Biological Products' Balance Sheet?

We can see from the most recent balance sheet that Chongqing Zhifei Biological Products had liabilities of CN¥20.2b falling due within a year, and liabilities of CN¥693.1m due beyond that. On the other hand, it had cash of CN¥2.97b and CN¥30.0b worth of receivables due within a year. So it can boast CN¥12.1b more liquid assets than total liabilities.

It's good to see that Chongqing Zhifei Biological Products has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders.

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.

Chongqing Zhifei Biological Products has a low debt to EBITDA ratio of only 0.23. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. On the other hand, Chongqing Zhifei Biological Products saw its EBIT drop by 4.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Chongqing Zhifei Biological Products can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. In the last three years, Chongqing Zhifei Biological Products's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Chongqing Zhifei Biological Products's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. When we consider the range of factors above, it looks like Chongqing Zhifei Biological Products is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Chongqing Zhifei Biological Products you should know about.

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.

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