Here's Why Guangdong Sunwill Precising PlasticLtd (SZSE:002676) Has A Meaningful Debt Burden

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.' 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 Guangdong Sunwill Precising Plastic Co.,Ltd (SZSE:002676) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Guangdong Sunwill Precising PlasticLtd

What Is Guangdong Sunwill Precising PlasticLtd's Net Debt?

As you can see below, at the end of September 2023, Guangdong Sunwill Precising PlasticLtd had CN¥634.2m of debt, up from CN¥472.9m a year ago. Click the image for more detail. On the flip side, it has CN¥160.7m in cash leading to net debt of about CN¥473.5m.

How Strong Is Guangdong Sunwill Precising PlasticLtd's Balance Sheet?

The latest balance sheet data shows that Guangdong Sunwill Precising PlasticLtd had liabilities of CN¥1.13b due within a year, and liabilities of CN¥215.5m falling due after that. Offsetting these obligations, it had cash of CN¥160.7m as well as receivables valued at CN¥1.08b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥109.4m.

Since publicly traded Guangdong Sunwill Precising PlasticLtd shares are worth a total of CN¥3.66b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Guangdong Sunwill Precising PlasticLtd's debt to EBITDA ratio (4.9) suggests that it uses some debt, its interest cover is very weak, at 1.7, 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. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. The good news is that Guangdong Sunwill Precising PlasticLtd grew its EBIT a smooth 92% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Guangdong Sunwill Precising PlasticLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Guangdong Sunwill Precising PlasticLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Guangdong Sunwill Precising PlasticLtd's conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Guangdong Sunwill Precising PlasticLtd is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For example, we've discovered 1 warning sign for Guangdong Sunwill Precising PlasticLtd that you should be aware of before investing here.

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.