Gongniu GroupLtd (SHSE:603195) Could Easily Take On More Debt

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 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, Gongniu Group Co.,Ltd. (SHSE:603195) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Gongniu GroupLtd

What Is Gongniu GroupLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Gongniu GroupLtd had CN¥1.03b of debt in September 2023, down from CN¥1.12b, one year before. But it also has CN¥13.8b in cash to offset that, meaning it has CN¥12.8b net cash.

How Strong Is Gongniu GroupLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gongniu GroupLtd had liabilities of CN¥5.08b due within 12 months and liabilities of CN¥249.7m due beyond that. Offsetting these obligations, it had cash of CN¥13.8b as well as receivables valued at CN¥207.4m due within 12 months. So it can boast CN¥8.66b more liquid assets than total liabilities.

This surplus suggests that Gongniu GroupLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Gongniu GroupLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Gongniu GroupLtd grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Gongniu GroupLtd 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. Gongniu GroupLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Gongniu GroupLtd recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Gongniu GroupLtd has net cash of CN¥12.8b, as well as more liquid assets than liabilities. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in CN¥4.4b. So is Gongniu GroupLtd's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Gongniu GroupLtd has 1 warning sign we think you should be aware of.

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.