Guangxi LiuYao Group (SHSE:603368) Has A Pretty Healthy Balance Sheet

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 Guangxi LiuYao Group Co., Ltd (SHSE:603368) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Guangxi LiuYao Group

How Much Debt Does Guangxi LiuYao Group Carry?

As you can see below, at the end of March 2024, Guangxi LiuYao Group had CN¥5.03b of debt, up from CN¥4.44b a year ago. Click the image for more detail. On the flip side, it has CN¥2.06b in cash leading to net debt of about CN¥2.97b.

A Look At Guangxi LiuYao Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Guangxi LiuYao Group had liabilities of CN¥11.7b due within 12 months and liabilities of CN¥1.56b due beyond that. Offsetting this, it had CN¥2.06b in cash and CN¥12.5b in receivables that were due within 12 months. So it can boast CN¥1.27b more liquid assets than total liabilities.

This short term liquidity is a sign that Guangxi LiuYao Group could probably pay off its debt with ease, as its balance sheet is far from stretched.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Guangxi LiuYao Group has net debt worth 2.1 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.6 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. One way Guangxi LiuYao Group could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 16%, as it did over the last year. 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 Guangxi LiuYao Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Guangxi LiuYao Group's free cash flow amounted to 35% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Guangxi LiuYao Group's impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. It's also worth noting that Guangxi LiuYao Group is in the Healthcare industry, which is often considered to be quite defensive. When we consider the range of factors above, it looks like Guangxi LiuYao Group is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Guangxi LiuYao Group has 3 warning signs (and 1 which is a bit concerning) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.