Guangdong TCL Smart Home Appliances (SZSE:002668) Could Easily Take On More 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.' 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. As with many other companies Guangdong TCL Smart Home Appliances Co., Ltd. (SZSE:002668) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Guangdong TCL Smart Home Appliances

What Is Guangdong TCL Smart Home Appliances's Net Debt?

As you can see below, Guangdong TCL Smart Home Appliances had CN¥686.9m of debt at March 2024, down from CN¥803.2m a year prior. However, its balance sheet shows it holds CN¥4.07b in cash, so it actually has CN¥3.39b net cash.

How Strong Is Guangdong TCL Smart Home Appliances' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangdong TCL Smart Home Appliances had liabilities of CN¥9.36b due within 12 months and liabilities of CN¥605.9m due beyond that. On the other hand, it had cash of CN¥4.07b and CN¥3.74b worth of receivables due within a year. So it has liabilities totalling CN¥2.15b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Guangdong TCL Smart Home Appliances has a market capitalization of CN¥9.02b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Guangdong TCL Smart Home Appliances also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Guangdong TCL Smart Home Appliances grew its EBIT by 49% over the last twelve months, and that growth will make it easier to handle its debt. 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 TCL Smart Home Appliances 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Guangdong TCL Smart Home Appliances may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Guangdong TCL Smart Home Appliances recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Guangdong TCL Smart Home Appliances's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥3.39b. And it impressed us with free cash flow of CN¥2.2b, being 98% of its EBIT. So is Guangdong TCL Smart Home Appliances's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Guangdong TCL Smart Home Appliances , and understanding them should be part of your investment process.

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.

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