Guangdong Create Century Intelligent Equipment Group (SZSE:300083) Takes On Some Risk With Its Use Of Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Guangdong Create Century Intelligent Equipment Group Corporation Limited (SZSE:300083) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Guangdong Create Century Intelligent Equipment Group

How Much Debt Does Guangdong Create Century Intelligent Equipment Group Carry?

The image below, which you can click on for greater detail, shows that Guangdong Create Century Intelligent Equipment Group had debt of CN¥1.63b at the end of June 2024, a reduction from CN¥1.89b over a year. On the flip side, it has CN¥1.37b in cash leading to net debt of about CN¥258.6m.

How Strong Is Guangdong Create Century Intelligent Equipment Group's Balance Sheet?

According to the last reported balance sheet, Guangdong Create Century Intelligent Equipment Group had liabilities of CN¥4.06b due within 12 months, and liabilities of CN¥819.3m due beyond 12 months. Offsetting this, it had CN¥1.37b in cash and CN¥2.50b in receivables that were due within 12 months. So its liabilities total CN¥1.01b more than the combination of its cash and short-term receivables.

Given Guangdong Create Century Intelligent Equipment Group has a market capitalization of CN¥12.6b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Even though Guangdong Create Century Intelligent Equipment Group's debt is only 1.7, its interest cover is really very low at 1.6. The main reason for this is that it has such high depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) Either way there's no doubt the stock is using meaningful leverage. Shareholders should be aware that Guangdong Create Century Intelligent Equipment Group's EBIT was down 78% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Guangdong Create Century Intelligent Equipment Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Guangdong Create Century Intelligent Equipment Group's free cash flow amounted to 21% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On the face of it, Guangdong Create Century Intelligent Equipment Group's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Guangdong Create Century Intelligent Equipment Group stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. Case in point: We've spotted 2 warning signs for Guangdong Create Century Intelligent Equipment Group you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.