Does Foshan Golden Milky Way Intelligent Equipment (SZSE:300619) Have A Healthy Balance Sheet?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Foshan Golden Milky Way Intelligent Equipment Co., Ltd. (SZSE:300619) does have debt on its balance sheet. But is this debt a concern to shareholders?

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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Foshan Golden Milky Way Intelligent Equipment

How Much Debt Does Foshan Golden Milky Way Intelligent Equipment Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Foshan Golden Milky Way Intelligent Equipment had debt of CN¥1.60b, up from CN¥1.23b in one year. However, because it has a cash reserve of CN¥686.1m, its net debt is less, at about CN¥916.8m.

How Strong Is Foshan Golden Milky Way Intelligent Equipment's Balance Sheet?

We can see from the most recent balance sheet that Foshan Golden Milky Way Intelligent Equipment had liabilities of CN¥2.36b falling due within a year, and liabilities of CN¥360.7m due beyond that. On the other hand, it had cash of CN¥686.1m and CN¥1.27b worth of receivables due within a year. So its liabilities total CN¥764.7m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Foshan Golden Milky Way Intelligent Equipment is worth CN¥3.52b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.1 times and a disturbingly high net debt to EBITDA ratio of 5.4 hit our confidence in Foshan Golden Milky Way Intelligent Equipment like a one-two punch to the gut. The debt burden here is substantial. Worse, Foshan Golden Milky Way Intelligent Equipment's EBIT was down 59% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Foshan Golden Milky Way Intelligent Equipment will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. Over the last three years, Foshan Golden Milky Way Intelligent Equipment saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Foshan Golden Milky Way Intelligent Equipment's conversion of EBIT to free cash flow 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. Having said that, its ability to handle its total liabilities isn't such a worry. Overall, it seems to us that Foshan Golden Milky Way Intelligent Equipment's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Be aware that Foshan Golden Milky Way Intelligent Equipment is showing 6 warning signs in our investment analysis , and 4 of those make us uncomfortable...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.