Here's Why Zhejiang China Light&Textile Industrial City GroupLtd (SHSE:600790) Has A Meaningful Debt Burden

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Zhejiang China Light&Textile Industrial City Group Co.,Ltd (SHSE:600790) 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Zhejiang China Light&Textile Industrial City GroupLtd

What Is Zhejiang China Light&Textile Industrial City GroupLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Zhejiang China Light&Textile Industrial City GroupLtd had CN¥2.48b of debt, an increase on CN¥2.30b, over one year. However, it also had CN¥1.65b in cash, and so its net debt is CN¥830.9m.

How Strong Is Zhejiang China Light&Textile Industrial City GroupLtd's Balance Sheet?

According to the last reported balance sheet, Zhejiang China Light&Textile Industrial City GroupLtd had liabilities of CN¥3.17b due within 12 months, and liabilities of CN¥2.60b due beyond 12 months. On the other hand, it had cash of CN¥1.65b and CN¥421.5m worth of receivables due within a year. So its liabilities total CN¥3.70b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥5.19b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

We'd say that Zhejiang China Light&Textile Industrial City GroupLtd's moderate net debt to EBITDA ratio ( being 2.2), indicates prudence when it comes to debt. And its strong interest cover of 1k times, makes us even more comfortable. Shareholders should be aware that Zhejiang China Light&Textile Industrial City GroupLtd's EBIT was down 20% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is Zhejiang China Light&Textile Industrial City GroupLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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, Zhejiang China Light&Textile Industrial City GroupLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Zhejiang China Light&Textile Industrial City GroupLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that Zhejiang China Light&Textile Industrial City GroupLtd's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Zhejiang China Light&Textile Industrial City GroupLtd has 2 warning signs we think you should be aware of.

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.