We Think Wutong Holding Group (SZSE:300292) 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 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. Importantly, Wutong Holding Group Co., Ltd. (SZSE:300292) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for Wutong Holding Group

What Is Wutong Holding Group's Debt?

The image below, which you can click on for greater detail, shows that Wutong Holding Group had debt of CN¥526.4m at the end of March 2024, a reduction from CN¥572.9m over a year. However, because it has a cash reserve of CN¥407.6m, its net debt is less, at about CN¥118.8m.

How Strong Is Wutong Holding Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wutong Holding Group had liabilities of CN¥1.27b due within 12 months and liabilities of CN¥3.72m due beyond that. Offsetting this, it had CN¥407.6m in cash and CN¥1.57b in receivables that were due within 12 months. So it actually has CN¥702.1m more liquid assets than total liabilities.

This surplus suggests that Wutong Holding Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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.

With net debt sitting at just 1.1 times EBITDA, Wutong Holding Group is arguably pretty conservatively geared. And it boasts interest cover of 7.7 times, which is more than adequate. On the other hand, Wutong Holding Group's EBIT dived 13%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is Wutong Holding Group'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, 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. Over the last three years, Wutong Holding Group recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Wutong Holding Group's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its EBIT growth rate. Taking all this data into account, it seems to us that Wutong Holding Group takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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 3 warning signs with Wutong Holding Group , and understanding them should be part of your investment process.

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.