We Think Guangdong Sunwill Precising PlasticLtd (SZSE:002676) Can Stay On Top Of Its 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Guangdong Sunwill Precising Plastic Co.,Ltd (SZSE:002676) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 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?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Guangdong Sunwill Precising PlasticLtd had CN¥1.32b of debt, an increase on CN¥634.2m, over one year. However, because it has a cash reserve of CN¥278.2m, its net debt is less, at about CN¥1.04b.

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

Zooming in on the latest balance sheet data, we can see that Guangdong Sunwill Precising PlasticLtd had liabilities of CN¥1.76b due within 12 months and liabilities of CN¥589.6m due beyond that. Offsetting this, it had CN¥278.2m in cash and CN¥1.42b in receivables that were due within 12 months. So it has liabilities totalling CN¥650.4m more than its cash and near-term receivables, combined.

Given Guangdong Sunwill Precising PlasticLtd has a market capitalization of CN¥4.54b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With a net debt to EBITDA ratio of 6.9, it's fair to say Guangdong Sunwill Precising PlasticLtd does have a significant amount of debt. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. The good news is that Guangdong Sunwill Precising PlasticLtd grew its EBIT a smooth 87% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Guangdong Sunwill Precising PlasticLtd'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Guangdong Sunwill Precising PlasticLtd created free cash flow amounting to 9.1% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Guangdong Sunwill Precising PlasticLtd's net debt to EBITDA was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to grow its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about Guangdong Sunwill Precising PlasticLtd's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more 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. Case in point: We've spotted 1 warning sign for Guangdong Sunwill Precising PlasticLtd you should be aware of.

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.