Here's Why Guangzhou Zhiguang ElectricLtd (SZSE:002169) Can Afford Some Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Guangzhou Zhiguang Electric Co.,Ltd. (SZSE:002169) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

Check out our latest analysis for Guangzhou Zhiguang ElectricLtd

How Much Debt Does Guangzhou Zhiguang ElectricLtd Carry?

As you can see below, at the end of September 2024, Guangzhou Zhiguang ElectricLtd had CN¥2.34b of debt, up from CN¥1.67b a year ago. Click the image for more detail. However, it also had CN¥723.9m in cash, and so its net debt is CN¥1.62b.

A Look At Guangzhou Zhiguang ElectricLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Guangzhou Zhiguang ElectricLtd had liabilities of CN¥3.57b due within 12 months and liabilities of CN¥1.92b due beyond that. Offsetting these obligations, it had cash of CN¥723.9m as well as receivables valued at CN¥2.16b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.61b.

This deficit isn't so bad because Guangzhou Zhiguang ElectricLtd is worth CN¥4.87b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Guangzhou Zhiguang ElectricLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Guangzhou Zhiguang ElectricLtd's revenue was pretty flat, and it made a negative EBIT. While that hardly impresses, its not too bad either.

Caveat Emptor

Importantly, Guangzhou Zhiguang ElectricLtd had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥73m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥1.1b of cash over the last year. So suffice it to say we consider the stock very risky. 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. Case in point: We've spotted 3 warning signs for Guangzhou Zhiguang ElectricLtd you should be aware of.

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.

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.