Is Anhui Guangxin Agrochemical (SHSE:603599) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Anhui Guangxin Agrochemical Co., Ltd. (SHSE:603599) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Anhui Guangxin Agrochemical

How Much Debt Does Anhui Guangxin Agrochemical Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Anhui Guangxin Agrochemical had debt of CN¥3.73b, up from CN¥2.19b in one year. However, it does have CN¥11.1b in cash offsetting this, leading to net cash of CN¥7.36b.

A Look At Anhui Guangxin Agrochemical's Liabilities

The latest balance sheet data shows that Anhui Guangxin Agrochemical had liabilities of CN¥5.93b due within a year, and liabilities of CN¥110.9m falling due after that. Offsetting these obligations, it had cash of CN¥11.1b as well as receivables valued at CN¥709.2m due within 12 months. So it actually has CN¥5.77b more liquid assets than total liabilities.

This excess liquidity is a great indication that Anhui Guangxin Agrochemical's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Anhui Guangxin Agrochemical has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Anhui Guangxin Agrochemical's saving grace is its low debt levels, because its EBIT has tanked 71% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Anhui Guangxin Agrochemical 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Anhui Guangxin Agrochemical 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 most recent three years, Anhui Guangxin Agrochemical recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Anhui Guangxin Agrochemical has CN¥7.36b in net cash and a decent-looking balance sheet. So we don't think Anhui Guangxin Agrochemical's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Anhui Guangxin Agrochemical (of which 1 is potentially serious!) you should know about.

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.