Is Quzhou Xin'an Development (SHSE:600208) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Quzhou Xin'an Development Co., Ltd. (SHSE:600208) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Quzhou Xin'an Development

What Is Quzhou Xin'an Development's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Quzhou Xin'an Development had debt of CN¥36.0b, up from CN¥32.7b in one year. However, it also had CN¥6.87b in cash, and so its net debt is CN¥29.2b.

How Strong Is Quzhou Xin'an Development's Balance Sheet?

The latest balance sheet data shows that Quzhou Xin'an Development had liabilities of CN¥43.8b due within a year, and liabilities of CN¥12.4b falling due after that. On the other hand, it had cash of CN¥6.87b and CN¥2.37b worth of receivables due within a year. So it has liabilities totalling CN¥47.0b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥25.4b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Quzhou Xin'an Development would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Quzhou Xin'an Development's net debt is 4.4 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Notably, Quzhou Xin'an Development's EBIT launched higher than Elon Musk, gaining a whopping 6,350% on last year. 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 Quzhou Xin'an Development 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Quzhou Xin'an Development generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Quzhou Xin'an Development's level of total liabilities was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. Looking at all this data makes us feel a little cautious about Quzhou Xin'an Development's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Quzhou Xin'an Development is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.