Here's Why CNGR Advanced MaterialLtd (SZSE:300919) Has A Meaningful Debt Burden

Warren Buffett famously said, '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 CNGR Advanced Material Co.,Ltd. (SZSE:300919) 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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for CNGR Advanced MaterialLtd

What Is CNGR Advanced MaterialLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 CNGR Advanced MaterialLtd had debt of CN¥27.5b, up from CN¥22.7b in one year. However, because it has a cash reserve of CN¥14.4b, its net debt is less, at about CN¥13.1b.

How Strong Is CNGR Advanced MaterialLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CNGR Advanced MaterialLtd had liabilities of CN¥20.6b due within 12 months and liabilities of CN¥22.1b due beyond that. Offsetting these obligations, it had cash of CN¥14.4b as well as receivables valued at CN¥5.31b due within 12 months. So its liabilities total CN¥22.9b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥36.0b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

CNGR Advanced MaterialLtd has a debt to EBITDA ratio of 3.5 and its EBIT covered its interest expense 3.6 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, one redeeming factor is that CNGR Advanced MaterialLtd grew its EBIT at 14% over the last 12 months, boosting its ability to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CNGR Advanced MaterialLtd 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, CNGR Advanced MaterialLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We'd go so far as to say CNGR Advanced MaterialLtd's conversion of EBIT to free cash flow was disappointing. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that CNGR Advanced MaterialLtd's debt is making it 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for CNGR Advanced MaterialLtd (1 is a bit concerning) 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.