We Think Guangdong Hoshion Industrial Aluminium (SZSE:002824) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Guangdong Hoshion Industrial Aluminium Co., Ltd. (SZSE:002824) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Guangdong Hoshion Industrial Aluminium

How Much Debt Does Guangdong Hoshion Industrial Aluminium Carry?

As you can see below, at the end of March 2024, Guangdong Hoshion Industrial Aluminium had CN¥1.09b of debt, up from CN¥420.8m a year ago. Click the image for more detail. However, it also had CN¥399.6m in cash, and so its net debt is CN¥686.5m.

How Healthy Is Guangdong Hoshion Industrial Aluminium's Balance Sheet?

According to the last reported balance sheet, Guangdong Hoshion Industrial Aluminium had liabilities of CN¥1.51b due within 12 months, and liabilities of CN¥586.2m due beyond 12 months. On the other hand, it had cash of CN¥399.6m and CN¥1.47b worth of receivables due within a year. So it has liabilities totalling CN¥231.2m more than its cash and near-term receivables, combined.

Of course, Guangdong Hoshion Industrial Aluminium has a market capitalization of CN¥3.95b, so these liabilities are probably manageable. 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 net debt to EBITDA of 2.8 Guangdong Hoshion Industrial Aluminium has a fairly noticeable amount of debt. But the high interest coverage of 7.8 suggests it can easily service that debt. Shareholders should be aware that Guangdong Hoshion Industrial Aluminium's EBIT was down 29% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Guangdong Hoshion Industrial Aluminium'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Guangdong Hoshion Industrial Aluminium burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Guangdong Hoshion Industrial Aluminium's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Guangdong Hoshion Industrial Aluminium's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. Case in point: We've spotted 4 warning signs for Guangdong Hoshion Industrial Aluminium you should be aware of, and 1 of them doesn't sit too well with us.

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.