These 4 Measures Indicate That Zhejiang Chang'an Renheng Technology (HKG:8139) Is Using Debt Extensively

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.' 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. Importantly, Zhejiang Chang'an Renheng Technology Co., Ltd. (HKG:8139) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Zhejiang Chang'an Renheng Technology

What Is Zhejiang Chang'an Renheng Technology's Debt?

The chart below, which you can click on for greater detail, shows that Zhejiang Chang'an Renheng Technology had CN¥121.3m in debt in June 2023; about the same as the year before. On the flip side, it has CN¥18.6m in cash leading to net debt of about CN¥102.7m.

How Strong Is Zhejiang Chang'an Renheng Technology's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Chang'an Renheng Technology had liabilities of CN¥107.5m falling due within a year, and liabilities of CN¥53.0m due beyond that. Offsetting these obligations, it had cash of CN¥18.6m as well as receivables valued at CN¥78.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥63.4m.

When you consider that this deficiency exceeds the company's CN¥50.7m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Zhejiang Chang'an Renheng Technology's debt to EBITDA ratio (4.5) suggests that it uses some debt, its interest cover is very weak, at 2.0, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Looking on the bright side, Zhejiang Chang'an Renheng Technology boosted its EBIT by a silky 60% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Zhejiang Chang'an Renheng Technology'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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Zhejiang Chang'an Renheng Technology reported free cash flow worth 7.0% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On the face of it, Zhejiang Chang'an Renheng Technology's level of total liabilities left us tentative about the stock, and its interest cover was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Zhejiang Chang'an Renheng Technology's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. We've identified 3 warning signs with Zhejiang Chang'an Renheng Technology (at least 2 which don't sit too well with us) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.