Stock Analysis

We Think Guizhou TyreLtd (SZSE:000589) Can Stay On Top Of Its Debt

SZSE:000589
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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Guizhou Tyre Co.,Ltd. (SZSE:000589) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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 Guizhou TyreLtd

What Is Guizhou TyreLtd's Debt?

The chart below, which you can click on for greater detail, shows that Guizhou TyreLtd had CN¥4.93b in debt in March 2024; about the same as the year before. However, because it has a cash reserve of CN¥3.14b, its net debt is less, at about CN¥1.79b.

debt-equity-history-analysis
SZSE:000589 Debt to Equity History August 22nd 2024

How Strong Is Guizhou TyreLtd's Balance Sheet?

According to the last reported balance sheet, Guizhou TyreLtd had liabilities of CN¥8.50b due within 12 months, and liabilities of CN¥1.73b due beyond 12 months. On the other hand, it had cash of CN¥3.14b and CN¥3.30b worth of receivables due within a year. So its liabilities total CN¥3.79b more than the combination of its cash and short-term receivables.

Guizhou TyreLtd has a market capitalization of CN¥6.77b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

Guizhou TyreLtd's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 30.3 times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Guizhou TyreLtd grew its EBIT by 139% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Guizhou TyreLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Guizhou TyreLtd 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

Based on what we've seen Guizhou TyreLtd is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Guizhou TyreLtd'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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Guizhou TyreLtd 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.