Is Gemac Engineering Machinery (SZSE:301048) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Gemac Engineering Machinery Co., Ltd. (SZSE:301048) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Gemac Engineering Machinery

What Is Gemac Engineering Machinery's Net Debt?

The chart below, which you can click on for greater detail, shows that Gemac Engineering Machinery had CN¥250.2m in debt in March 2024; about the same as the year before. However, its balance sheet shows it holds CN¥830.8m in cash, so it actually has CN¥580.6m net cash.

How Healthy Is Gemac Engineering Machinery's Balance Sheet?

The latest balance sheet data shows that Gemac Engineering Machinery had liabilities of CN¥2.54b due within a year, and liabilities of CN¥158.5m falling due after that. Offsetting these obligations, it had cash of CN¥830.8m as well as receivables valued at CN¥2.05b due within 12 months. So it can boast CN¥179.9m more liquid assets than total liabilities.

This surplus suggests that Gemac Engineering Machinery has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Gemac Engineering Machinery boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Gemac Engineering Machinery's EBIT dived 12%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Gemac Engineering Machinery 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Gemac Engineering Machinery 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. In the last three years, Gemac Engineering Machinery basically broke even on a free cash flow basis. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Gemac Engineering Machinery has net cash of CN¥580.6m, as well as more liquid assets than liabilities. So we are not troubled with Gemac Engineering Machinery's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Gemac Engineering Machinery's earnings per share history for free.

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.

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