Is Zhejiang Shengyang Science and TechnologyLtd (SHSE:603703) A Risky Investment?

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.' 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 Zhejiang Shengyang Science and Technology Co.,Ltd. (SHSE:603703) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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, 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.

View our latest analysis for Zhejiang Shengyang Science and TechnologyLtd

What Is Zhejiang Shengyang Science and TechnologyLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhejiang Shengyang Science and TechnologyLtd had CN¥826.2m of debt, an increase on CN¥716.2m, over one year. However, because it has a cash reserve of CN¥376.6m, its net debt is less, at about CN¥449.6m.

A Look At Zhejiang Shengyang Science and TechnologyLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Zhejiang Shengyang Science and TechnologyLtd had liabilities of CN¥1.06b due within 12 months and liabilities of CN¥23.8m due beyond that. On the other hand, it had cash of CN¥376.6m and CN¥297.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥409.9m.

Since publicly traded Zhejiang Shengyang Science and TechnologyLtd shares are worth a total of CN¥5.23b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). 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).

Weak interest cover of 0.13 times and a disturbingly high net debt to EBITDA ratio of 6.5 hit our confidence in Zhejiang Shengyang Science and TechnologyLtd like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Zhejiang Shengyang Science and TechnologyLtd saw its EBIT tank 89% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Zhejiang Shengyang Science and TechnologyLtd will need earnings to service that debt. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last two years, Zhejiang Shengyang Science and 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

To be frank both Zhejiang Shengyang Science and TechnologyLtd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. Overall, it seems to us that Zhejiang Shengyang Science and TechnologyLtd's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. We've identified 2 warning signs with Zhejiang Shengyang Science and TechnologyLtd (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.