Gold cup Electric ApparatusLtd (SZSE:002533) Could Easily Take On More Debt

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. Importantly, Gold cup Electric Apparatus Co.,Ltd. (SZSE:002533) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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.

See our latest analysis for Gold cup Electric ApparatusLtd

What Is Gold cup Electric ApparatusLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Gold cup Electric ApparatusLtd had CN¥1.04b of debt, an increase on CN¥965.8m, over one year. However, it does have CN¥830.9m in cash offsetting this, leading to net debt of about CN¥205.0m.

A Look At Gold cup Electric ApparatusLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Gold cup Electric ApparatusLtd had liabilities of CN¥2.98b due within 12 months and liabilities of CN¥907.5m due beyond that. On the other hand, it had cash of CN¥830.9m and CN¥3.12b worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Gold cup Electric ApparatusLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥7.09b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Gold cup Electric ApparatusLtd has a low debt to EBITDA ratio of only 0.25. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. In addition to that, we're happy to report that Gold cup Electric ApparatusLtd has boosted its EBIT by 33%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Gold cup Electric ApparatusLtd 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Gold cup Electric ApparatusLtd recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Gold cup Electric ApparatusLtd's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Gold cup Electric ApparatusLtd seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 instance, we've identified 1 warning sign for Gold cup Electric ApparatusLtd that 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com