Milkyway Chemical Supply Chain ServiceLtd (SHSE:603713) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Milkyway Chemical Supply Chain Service Co.,Ltd (SHSE:603713) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Milkyway Chemical Supply Chain ServiceLtd

What Is Milkyway Chemical Supply Chain ServiceLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Milkyway Chemical Supply Chain ServiceLtd had CN¥4.38b of debt, an increase on CN¥3.04b, over one year. However, it also had CN¥1.43b in cash, and so its net debt is CN¥2.95b.

A Look At Milkyway Chemical Supply Chain ServiceLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Milkyway Chemical Supply Chain ServiceLtd had liabilities of CN¥4.67b due within 12 months and liabilities of CN¥2.22b due beyond that. Offsetting this, it had CN¥1.43b in cash and CN¥3.39b in receivables that were due within 12 months. So it has liabilities totalling CN¥2.07b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Milkyway Chemical Supply Chain ServiceLtd has a market capitalization of CN¥8.86b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). 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).

Milkyway Chemical Supply Chain ServiceLtd's debt is 3.3 times its EBITDA, and its EBIT cover its interest expense 6.5 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly Milkyway Chemical Supply Chain ServiceLtd's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Milkyway Chemical Supply Chain ServiceLtd'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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Milkyway Chemical Supply Chain ServiceLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We'd go so far as to say Milkyway Chemical Supply Chain ServiceLtd's conversion of EBIT to free cash flow was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Milkyway Chemical Supply Chain ServiceLtd stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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 Milkyway Chemical Supply Chain ServiceLtd has 2 warning signs (and 1 which is concerning) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com