Is Guangzhou KDT MachineryLtd (SZSE:002833) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Guangzhou KDT Machinery Co.,Ltd. (SZSE:002833) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 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, 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 KDT MachineryLtd

How Much Debt Does Guangzhou KDT MachineryLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Guangzhou KDT MachineryLtd had CN¥689.5m of debt, an increase on CN¥549.6m, over one year. But it also has CN¥1.56b in cash to offset that, meaning it has CN¥867.2m net cash.

A Look At Guangzhou KDT MachineryLtd's Liabilities

According to the last reported balance sheet, Guangzhou KDT MachineryLtd had liabilities of CN¥605.3m due within 12 months, and liabilities of CN¥658.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.56b as well as receivables valued at CN¥161.1m due within 12 months. So it actually has CN¥453.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Guangzhou KDT MachineryLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Guangzhou KDT MachineryLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Guangzhou KDT MachineryLtd grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Guangzhou KDT MachineryLtd'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 company can only pay off debt with cold hard cash, not accounting profits. While Guangzhou KDT MachineryLtd 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. Looking at the most recent three years, Guangzhou KDT MachineryLtd recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangzhou KDT MachineryLtd has CN¥867.2m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 42% over the last year. So is Guangzhou KDT MachineryLtd's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 2 warning signs for Guangzhou KDT MachineryLtd (1 is concerning!) that you should be aware of before investing here.

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.

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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.