Is Changgao Electric Group (SZSE:002452) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Changgao Electric Group Co., Ltd. (SZSE:002452) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for Changgao Electric Group

How Much Debt Does Changgao Electric Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Changgao Electric Group had CN¥145.5m of debt, an increase on CN¥139.7m, over one year. But on the other hand it also has CN¥738.3m in cash, leading to a CN¥592.8m net cash position.

How Healthy Is Changgao Electric Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Changgao Electric Group had liabilities of CN¥601.9m due within 12 months and liabilities of CN¥281.6m due beyond that. On the other hand, it had cash of CN¥738.3m and CN¥1.03b worth of receivables due within a year. So it can boast CN¥880.0m more liquid assets than total liabilities.

This surplus suggests that Changgao Electric Group is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Changgao Electric Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Changgao Electric Group grew its EBIT by 109% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is Changgao Electric Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Changgao Electric Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Changgao Electric Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Changgao Electric Group has CN¥592.8m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 179% of that EBIT to free cash flow, bringing in CN¥193m. When it comes to Changgao Electric Group's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Changgao Electric Group you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.