Is Guangdong Guanghua Sci-Tech (SZSE:002741) Using Too Much Debt?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Guangdong Guanghua Sci-Tech Co., Ltd. (SZSE:002741) does carry debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Guangdong Guanghua Sci-Tech

What Is Guangdong Guanghua Sci-Tech's Net Debt?

The image below, which you can click on for greater detail, shows that Guangdong Guanghua Sci-Tech had debt of CN¥858.2m at the end of March 2024, a reduction from CN¥1.02b over a year. However, because it has a cash reserve of CN¥226.7m, its net debt is less, at about CN¥631.5m.

How Strong Is Guangdong Guanghua Sci-Tech's Balance Sheet?

The latest balance sheet data shows that Guangdong Guanghua Sci-Tech had liabilities of CN¥1.52b due within a year, and liabilities of CN¥240.9m falling due after that. Offsetting this, it had CN¥226.7m in cash and CN¥770.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥765.5m.

Given Guangdong Guanghua Sci-Tech has a market capitalization of CN¥4.21b, 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Guangdong Guanghua Sci-Tech's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Guangdong Guanghua Sci-Tech made a loss at the EBIT level, and saw its revenue drop to CN¥2.6b, which is a fall of 20%. That makes us nervous, to say the least.

Caveat Emptor

While Guangdong Guanghua Sci-Tech's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥406m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CN¥238m. So to be blunt we do think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Guangdong Guanghua Sci-Tech that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com