ChengDu Hi-Tech Development (SZSE:000628) Seems To Use Debt Quite Sensibly

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 ChengDu Hi-Tech Development Co., Ltd. (SZSE:000628) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for ChengDu Hi-Tech Development

What Is ChengDu Hi-Tech Development's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 ChengDu Hi-Tech Development had CN¥2.62b of debt, an increase on CN¥2.17b, over one year. However, because it has a cash reserve of CN¥512.5m, its net debt is less, at about CN¥2.11b.

A Look At ChengDu Hi-Tech Development's Liabilities

We can see from the most recent balance sheet that ChengDu Hi-Tech Development had liabilities of CN¥8.19b falling due within a year, and liabilities of CN¥2.04b due beyond that. Offsetting these obligations, it had cash of CN¥512.5m as well as receivables valued at CN¥9.28b due within 12 months. So it has liabilities totalling CN¥432.2m more than its cash and near-term receivables, combined.

Of course, ChengDu Hi-Tech Development has a market capitalization of CN¥18.4b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

As it happens ChengDu Hi-Tech Development has a fairly concerning net debt to EBITDA ratio of 5.1 but very strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly, ChengDu Hi-Tech Development grew its EBIT by 57% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is ChengDu Hi-Tech Development'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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, ChengDu Hi-Tech Development 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

ChengDu Hi-Tech Development's conversion of EBIT to free cash flow was a real negative on this analysis, as was its net debt to EBITDA. But its interest cover was significantly redeeming. Considering this range of data points, we think ChengDu Hi-Tech Development is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For example, we've discovered 3 warning signs for ChengDu Hi-Tech Development that you should be aware of before investing here.

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.