We Think Sichuan Guoguang Agrochemical (SZSE:002749) Can Manage Its Debt With Ease

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. As with many other companies Sichuan Guoguang Agrochemical Co., Ltd. (SZSE:002749) makes use of debt. 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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sichuan Guoguang Agrochemical

What Is Sichuan Guoguang Agrochemical's Debt?

The image below, which you can click on for greater detail, shows that Sichuan Guoguang Agrochemical had debt of CN¥68.7m at the end of June 2024, a reduction from CN¥356.2m over a year. But on the other hand it also has CN¥1.37b in cash, leading to a CN¥1.30b net cash position.

How Strong Is Sichuan Guoguang Agrochemical's Balance Sheet?

We can see from the most recent balance sheet that Sichuan Guoguang Agrochemical had liabilities of CN¥324.4m falling due within a year, and liabilities of CN¥97.7m due beyond that. On the other hand, it had cash of CN¥1.37b and CN¥133.7m worth of receivables due within a year. So it actually has CN¥1.08b more liquid assets than total liabilities.

This excess liquidity suggests that Sichuan Guoguang Agrochemical is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Sichuan Guoguang Agrochemical has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Sichuan Guoguang Agrochemical has boosted its EBIT by 74%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Sichuan Guoguang Agrochemical's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Sichuan Guoguang Agrochemical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Sichuan Guoguang Agrochemical generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sichuan Guoguang Agrochemical has CN¥1.30b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥347m, being 82% of its EBIT. When it comes to Sichuan Guoguang Agrochemical's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. For example - Sichuan Guoguang Agrochemical has 2 warning signs we think you should be aware of.

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.