Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Zhuzhou Kibing Group Co.,Ltd (SHSE:601636) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.
What Is Zhuzhou Kibing GroupLtd's Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Zhuzhou Kibing GroupLtd had debt of CN¥12.2b, up from CN¥7.50b in one year. On the flip side, it has CN¥3.40b in cash leading to net debt of about CN¥8.82b.
How Strong Is Zhuzhou Kibing GroupLtd's Balance Sheet?
The latest balance sheet data shows that Zhuzhou Kibing GroupLtd had liabilities of CN¥7.07b due within a year, and liabilities of CN¥11.3b falling due after that. Offsetting these obligations, it had cash of CN¥3.40b as well as receivables valued at CN¥2.26b due within 12 months. So its liabilities total CN¥12.7b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Zhuzhou Kibing GroupLtd is worth CN¥22.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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.
Zhuzhou Kibing GroupLtd's net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its strong interest cover of 13.4 times, makes us even more comfortable. Pleasingly, Zhuzhou Kibing GroupLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 191% gain in the last twelve months. 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 Zhuzhou Kibing GroupLtd'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Zhuzhou Kibing GroupLtd 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
Zhuzhou Kibing GroupLtd's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Zhuzhou Kibing GroupLtd's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Zhuzhou Kibing GroupLtd (2 are significant!) 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.