Here's Why Xiamen Changelight (SZSE:300102) Has A Meaningful Debt Burden

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Xiamen Changelight Co., Ltd. (SZSE:300102) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Xiamen Changelight

What Is Xiamen Changelight's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Xiamen Changelight had CN¥1.33b of debt, an increase on CN¥967.0m, over one year. However, it also had CN¥928.8m in cash, and so its net debt is CN¥404.2m.

A Look At Xiamen Changelight's Liabilities

According to the last reported balance sheet, Xiamen Changelight had liabilities of CN¥1.55b due within 12 months, and liabilities of CN¥839.2m due beyond 12 months. Offsetting this, it had CN¥928.8m in cash and CN¥1.22b in receivables that were due within 12 months. So it has liabilities totalling CN¥245.6m more than its cash and near-term receivables, combined.

Of course, Xiamen Changelight has a market capitalization of CN¥10.8b, 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Xiamen Changelight has a very low debt to EBITDA ratio of 0.93 so it is strange to see weak interest coverage, with last year's EBIT being only 1.7 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Notably, Xiamen Changelight made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥57m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Xiamen Changelight's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Xiamen Changelight 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

While Xiamen Changelight's interest cover makes us cautious about it, its track record of converting EBIT to free cash flow is no better. At least its net debt to EBITDA gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Xiamen Changelight is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Xiamen Changelight you should be aware of, and 1 of them is a bit concerning.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.