Is Guangdong Orient Zirconic Ind Sci & TechLtd (SZSE:002167) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Guangdong Orient Zirconic Ind Sci & Tech Co.,Ltd (SZSE:002167) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Guangdong Orient Zirconic Ind Sci & TechLtd

What Is Guangdong Orient Zirconic Ind Sci & TechLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Guangdong Orient Zirconic Ind Sci & TechLtd had debt of CN¥962.1m, up from CN¥473.0m in one year. However, it also had CN¥780.0m in cash, and so its net debt is CN¥182.1m.

How Healthy Is Guangdong Orient Zirconic Ind Sci & TechLtd's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Orient Zirconic Ind Sci & TechLtd had liabilities of CN¥2.15b falling due within a year, and liabilities of CN¥129.6m due beyond that. Offsetting these obligations, it had cash of CN¥780.0m as well as receivables valued at CN¥271.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.22b.

While this might seem like a lot, it is not so bad since Guangdong Orient Zirconic Ind Sci & TechLtd has a market capitalization of CN¥4.40b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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 Guangdong Orient Zirconic Ind Sci & TechLtd's debt to EBITDA ratio (2.6) suggests that it uses some debt, its interest cover is very weak, at 0.54, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Shareholders should be aware that Guangdong Orient Zirconic Ind Sci & TechLtd's EBIT was down 95% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is Guangdong Orient Zirconic Ind Sci & TechLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Guangdong Orient Zirconic Ind Sci & TechLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Guangdong Orient Zirconic Ind Sci & TechLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to handle its total liabilities isn't such a worry. We're quite clear that we consider Guangdong Orient Zirconic Ind Sci & TechLtd to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. While Guangdong Orient Zirconic Ind Sci & TechLtd didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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.