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. As with many other companies Zhejiang XCC Group Co.,Ltd (SHSE:603667) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Zhejiang XCC GroupLtd
What Is Zhejiang XCC GroupLtd's Debt?
You can click the graphic below for the historical numbers, but it shows that Zhejiang XCC GroupLtd had CN¥832.2m of debt in September 2023, down from CN¥1.15b, one year before. On the flip side, it has CN¥695.1m in cash leading to net debt of about CN¥137.1m.
How Healthy Is Zhejiang XCC GroupLtd's Balance Sheet?
According to the last reported balance sheet, Zhejiang XCC GroupLtd had liabilities of CN¥1.53b due within 12 months, and liabilities of CN¥276.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥695.1m as well as receivables valued at CN¥1.12b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This state of affairs indicates that Zhejiang XCC GroupLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥7.77b company is short on cash, but still worth keeping an eye on the balance sheet.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Zhejiang XCC GroupLtd has a low net debt to EBITDA ratio of only 0.58. And its EBIT easily covers its interest expense, being 11.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact Zhejiang XCC GroupLtd's saving grace is its low debt levels, because its EBIT has tanked 46% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhejiang XCC GroupLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Zhejiang XCC GroupLtd 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
While Zhejiang XCC GroupLtd's conversion of EBIT to free cash flow makes us cautious about it, its track record of (not) growing its EBIT is no better. But on the brighter side of life, its interest cover leaves us feeling more frolicsome. Taking the abovementioned factors together we do think Zhejiang XCC GroupLtd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. Case in point: We've spotted 4 warning signs for Zhejiang XCC GroupLtd you should be aware of, and 1 of them can't be ignored.
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.