We Think Changgao Electric Group (SZSE:002452) Can Manage Its Debt With Ease

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.' 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. We can see that Changgao Electric Group Co., Ltd. (SZSE:002452) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. 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?

The image below, which you can click on for greater detail, shows that Changgao Electric Group had debt of CN¥146.9m at the end of December 2023, a reduction from CN¥171.1m over a year. However, it does have CN¥923.9m in cash offsetting this, leading to net cash of CN¥777.0m.

How Strong Is Changgao Electric Group's Balance Sheet?

The latest balance sheet data shows that Changgao Electric Group had liabilities of CN¥688.6m due within a year, and liabilities of CN¥291.1m falling due after that. Offsetting these obligations, it had cash of CN¥923.9m as well as receivables valued at CN¥964.2m due within 12 months. So it actually has CN¥908.5m more liquid assets than total liabilities.

This excess liquidity suggests that Changgao Electric Group is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face 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 206% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Changgao Electric Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Changgao Electric Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Changgao Electric Group actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Changgao Electric Group has net cash of CN¥777.0m, as well as more liquid assets than liabilities. The cherry on top was that in converted 126% of that EBIT to free cash flow, bringing in CN¥186m. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Changgao Electric Group , and understanding them should be part of your investment process.

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.