Guizhou Zhenhua E-chem (SHSE:688707) Is Carrying A Fair Bit Of 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. We can see that Guizhou Zhenhua E-chem Inc. (SHSE:688707) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 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 Guizhou Zhenhua E-chem

What Is Guizhou Zhenhua E-chem's Debt?

The chart below, which you can click on for greater detail, shows that Guizhou Zhenhua E-chem had CN¥2.15b in debt in September 2024; about the same as the year before. However, it also had CN¥2.04b in cash, and so its net debt is CN¥112.1m.

A Look At Guizhou Zhenhua E-chem's Liabilities

The latest balance sheet data shows that Guizhou Zhenhua E-chem had liabilities of CN¥2.77b due within a year, and liabilities of CN¥570.2m falling due after that. Offsetting these obligations, it had cash of CN¥2.04b as well as receivables valued at CN¥1.50b due within 12 months. So it can boast CN¥192.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Guizhou Zhenhua E-chem could probably pay off its debt with ease, as its balance sheet is far from stretched. 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 Zhenhua E-chem can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Guizhou Zhenhua E-chem had a loss before interest and tax, and actually shrunk its revenue by 67%, to CN¥3.1b. That makes us nervous, to say the least.

Caveat Emptor

While Guizhou Zhenhua E-chem's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥284m. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. Still, we'd be more encouraged to study the business in depth if it already had some free cash flow. This one is a bit too risky for our liking. 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. Be aware that Guizhou Zhenhua E-chem is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.