Is Ninestar (SZSE:002180) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Ninestar Corporation (SZSE:002180) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Ninestar

How Much Debt Does Ninestar Carry?

You can click the graphic below for the historical numbers, but it shows that Ninestar had CN¥12.4b of debt in September 2024, down from CN¥14.1b, one year before. However, it does have CN¥6.51b in cash offsetting this, leading to net debt of about CN¥5.84b.

How Strong Is Ninestar's Balance Sheet?

According to the last reported balance sheet, Ninestar had liabilities of CN¥12.0b due within 12 months, and liabilities of CN¥14.8b due beyond 12 months. Offsetting these obligations, it had cash of CN¥6.51b as well as receivables valued at CN¥5.29b due within 12 months. So its liabilities total CN¥15.1b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Ninestar is worth CN¥38.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Ninestar's net debt is sitting at a very reasonable 2.2 times its EBITDA, while its EBIT covered its interest expense just 3.0 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, Ninestar grew its EBIT by 32% 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 future earnings, more than anything, that will determine Ninestar'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Ninestar produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Ninestar's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its interest cover has the opposite effect. All these things considered, it appears that Ninestar can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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 1 warning sign for Ninestar that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.