These 4 Measures Indicate That Guangxi Liugong Machinery (SZSE:000528) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We note that Guangxi Liugong Machinery Co., Ltd. (SZSE:000528) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Guangxi Liugong Machinery

What Is Guangxi Liugong Machinery's Debt?

You can click the graphic below for the historical numbers, but it shows that Guangxi Liugong Machinery had CN¥10.8b of debt in March 2024, down from CN¥12.7b, one year before. However, it also had CN¥8.86b in cash, and so its net debt is CN¥1.94b.

How Healthy Is Guangxi Liugong Machinery's Balance Sheet?

We can see from the most recent balance sheet that Guangxi Liugong Machinery had liabilities of CN¥22.2b falling due within a year, and liabilities of CN¥6.13b due beyond that. Offsetting these obligations, it had cash of CN¥8.86b as well as receivables valued at CN¥12.2b due within 12 months. So its liabilities total CN¥7.28b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Guangxi Liugong Machinery is worth CN¥18.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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).

Guangxi Liugong Machinery's net debt is only 0.87 times its EBITDA. And its EBIT easily covers its interest expense, being 89.0 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Guangxi Liugong Machinery grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Guangxi Liugong Machinery 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Guangxi Liugong Machinery reported free cash flow worth 19% 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

Happily, Guangxi Liugong Machinery's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Guangxi Liugong Machinery can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Guangxi Liugong Machinery has 2 warning signs we think you should be aware of.

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.