Tianjin Guoan Mengguli New Materials Science & Technology (SZSE:301487) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Tianjin Guoan Mengguli New Materials Science & Technology Co., Ltd. (SZSE:301487) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Tianjin Guoan Mengguli New Materials Science & Technology

What Is Tianjin Guoan Mengguli New Materials Science & Technology's Net Debt?

The image below, which you can click on for greater detail, shows that Tianjin Guoan Mengguli New Materials Science & Technology had debt of CN¥667.9m at the end of March 2024, a reduction from CN¥1.17b over a year. However, because it has a cash reserve of CN¥334.8m, its net debt is less, at about CN¥333.1m.

How Strong Is Tianjin Guoan Mengguli New Materials Science & Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tianjin Guoan Mengguli New Materials Science & Technology had liabilities of CN¥1.45b due within 12 months and liabilities of CN¥196.2m due beyond that. Offsetting these obligations, it had cash of CN¥334.8m as well as receivables valued at CN¥1.61b due within 12 months. So it actually has CN¥306.7m more liquid assets than total liabilities.

This surplus suggests that Tianjin Guoan Mengguli New Materials Science & Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Tianjin Guoan Mengguli New Materials Science & Technology has a quite reasonable net debt to EBITDA multiple of 2.1, its interest cover seems weak, at 2.1. 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. Importantly, Tianjin Guoan Mengguli New Materials Science & Technology's EBIT fell a jaw-dropping 33% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tianjin Guoan Mengguli New Materials Science & Technology 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, Tianjin Guoan Mengguli New Materials Science & Technology recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both Tianjin Guoan Mengguli New Materials Science & Technology's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. Once we consider all the factors above, together, it seems to us that Tianjin Guoan Mengguli New Materials Science & Technology's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Tianjin Guoan Mengguli New Materials Science & Technology , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.