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. We can see that Guangzhou Zhiguang Electric Co., Ltd. (SZSE:002169) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
View our latest analysis for Guangzhou Zhiguang Electric
What Is Guangzhou Zhiguang Electric's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Guangzhou Zhiguang Electric had CN¥1.67b of debt, an increase on CN¥1.35b, over one year. On the flip side, it has CN¥455.9m in cash leading to net debt of about CN¥1.21b.
How Strong Is Guangzhou Zhiguang Electric's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Guangzhou Zhiguang Electric had liabilities of CN¥2.96b due within 12 months and liabilities of CN¥687.9m due beyond that. Offsetting this, it had CN¥455.9m in cash and CN¥1.93b in receivables that were due within 12 months. So its liabilities total CN¥1.26b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Guangzhou Zhiguang Electric is worth CN¥4.58b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Guangzhou Zhiguang Electric will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Guangzhou Zhiguang Electric reported revenue of CN¥2.7b, which is a gain of 32%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
Caveat Emptor
Despite the top line growth, Guangzhou Zhiguang Electric still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥41m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥687m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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, we've discovered 3 warning signs for Guangzhou Zhiguang Electric (2 are a bit unpleasant!) that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.