We Think Hangzhou Changchuan TechnologyLtd (SZSE:300604) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Hangzhou Changchuan Technology Co.,Ltd (SZSE:300604) makes use of debt. But should shareholders be worried about its use of debt?

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 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 Hangzhou Changchuan TechnologyLtd

What Is Hangzhou Changchuan TechnologyLtd's Net Debt?

As you can see below, at the end of September 2024, Hangzhou Changchuan TechnologyLtd had CN¥1.08b of debt, up from CN¥910.3m a year ago. Click the image for more detail. However, it does have CN¥1.04b in cash offsetting this, leading to net debt of about CN¥44.3m.

How Healthy Is Hangzhou Changchuan TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Hangzhou Changchuan TechnologyLtd had liabilities of CN¥2.54b falling due within a year, and liabilities of CN¥443.7m due beyond that. Offsetting these obligations, it had cash of CN¥1.04b as well as receivables valued at CN¥1.50b due within 12 months. So its liabilities total CN¥450.7m more than the combination of its cash and short-term receivables.

Having regard to Hangzhou Changchuan TechnologyLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥27.7b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Hangzhou Changchuan TechnologyLtd has a very light debt load indeed.

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.

Hangzhou Changchuan TechnologyLtd has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.085 and EBIT of 48.6 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. Even more impressive was the fact that Hangzhou Changchuan TechnologyLtd grew its EBIT by 1,667% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hangzhou Changchuan TechnologyLtd's ability to maintain a healthy balance sheet going forward. 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, Hangzhou Changchuan TechnologyLtd 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

Happily, Hangzhou Changchuan TechnologyLtd's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. When we consider the range of factors above, it looks like Hangzhou Changchuan TechnologyLtd 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. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Hangzhou Changchuan TechnologyLtd that you should be aware of before investing here.

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.