We Think Greatoo Intelligent Equipment (SZSE:002031) Is Taking Some Risk With Its Debt

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Greatoo Intelligent Equipment Inc. (SZSE:002031) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Greatoo Intelligent Equipment

How Much Debt Does Greatoo Intelligent Equipment Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Greatoo Intelligent Equipment had CN¥1.23b of debt, an increase on CN¥1.15b, over one year. However, it does have CN¥171.5m in cash offsetting this, leading to net debt of about CN¥1.06b.

A Look At Greatoo Intelligent Equipment's Liabilities

Zooming in on the latest balance sheet data, we can see that Greatoo Intelligent Equipment had liabilities of CN¥1.44b due within 12 months and liabilities of CN¥481.8m due beyond that. On the other hand, it had cash of CN¥171.5m and CN¥525.3m worth of receivables due within a year. So its liabilities total CN¥1.23b more than the combination of its cash and short-term receivables.

Since publicly traded Greatoo Intelligent Equipment shares are worth a total of CN¥21.9b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.34 times and a disturbingly high net debt to EBITDA ratio of 8.3 hit our confidence in Greatoo Intelligent Equipment like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Greatoo Intelligent Equipment is that it turned last year's EBIT loss into a gain of CN¥20m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Greatoo Intelligent Equipment 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Greatoo Intelligent Equipment 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

To be frank both Greatoo Intelligent Equipment's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its level of total liabilities is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Greatoo Intelligent Equipment's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Greatoo Intelligent Equipment you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.