Does Guangzhou Baiyun Electric Equipment (SHSE:603861) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Guangzhou Baiyun Electric Equipment Co., Ltd. (SHSE:603861) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Guangzhou Baiyun Electric Equipment

How Much Debt Does Guangzhou Baiyun Electric Equipment Carry?

As you can see below, at the end of September 2024, Guangzhou Baiyun Electric Equipment had CN¥2.51b of debt, up from CN¥2.18b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥606.9m, its net debt is less, at about CN¥1.91b.

How Strong Is Guangzhou Baiyun Electric Equipment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangzhou Baiyun Electric Equipment had liabilities of CN¥4.98b due within 12 months and liabilities of CN¥1.57b due beyond that. On the other hand, it had cash of CN¥606.9m and CN¥2.23b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.71b.

This is a mountain of leverage relative to its market capitalization of CN¥5.11b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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

Guangzhou Baiyun Electric Equipment has a debt to EBITDA ratio of 4.8, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 12.8 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Notably, Guangzhou Baiyun Electric Equipment's EBIT launched higher than Elon Musk, gaining a whopping 238% on last year. 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 Baiyun Electric 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Guangzhou Baiyun Electric Equipment reported free cash flow worth 13% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Both Guangzhou Baiyun Electric Equipment's ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle handle its debt, based on its EBITDA,. When we consider all the factors mentioned above, we do feel a bit cautious about Guangzhou Baiyun Electric Equipment's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 2 warning signs for Guangzhou Baiyun Electric Equipment you should be aware of, and 1 of them is significant.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.