Is Guangzhou Tinci Materials Technology (SZSE:002709) A Risky Investment?

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.' 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 can see that Guangzhou Tinci Materials Technology Co., Ltd. (SZSE:002709) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Guangzhou Tinci Materials Technology

What Is Guangzhou Tinci Materials Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Guangzhou Tinci Materials Technology had debt of CN¥5.92b, up from CN¥5.06b in one year. However, it also had CN¥1.94b in cash, and so its net debt is CN¥3.98b.

How Strong Is Guangzhou Tinci Materials Technology's Balance Sheet?

We can see from the most recent balance sheet that Guangzhou Tinci Materials Technology had liabilities of CN¥7.05b falling due within a year, and liabilities of CN¥4.53b due beyond that. Offsetting this, it had CN¥1.94b in cash and CN¥6.68b in receivables that were due within 12 months. So it has liabilities totalling CN¥2.97b more than its cash and near-term receivables, combined.

Of course, Guangzhou Tinci Materials Technology has a market capitalization of CN¥43.4b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Guangzhou Tinci Materials Technology has a low net debt to EBITDA ratio of only 1.4. And its EBIT covers its interest expense a whopping 31.6 times over. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Guangzhou Tinci Materials Technology's load is not too heavy, because its EBIT was down 65% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Guangzhou Tinci Materials Technology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Guangzhou Tinci Materials Technology barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Our View

Neither Guangzhou Tinci Materials Technology's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Guangzhou Tinci Materials Technology is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Guangzhou Tinci Materials Technology , and understanding them should be part of your investment process.

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.