Tibet GaoZheng Explosive (SZSE:002827) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Tibet GaoZheng Explosive Co., Ltd. (SZSE:002827) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for Tibet GaoZheng Explosive

What Is Tibet GaoZheng Explosive's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Tibet GaoZheng Explosive had debt of CN¥1.16b, up from CN¥796.5m in one year. However, it does have CN¥773.3m in cash offsetting this, leading to net debt of about CN¥383.5m.

How Healthy Is Tibet GaoZheng Explosive's Balance Sheet?

We can see from the most recent balance sheet that Tibet GaoZheng Explosive had liabilities of CN¥770.7m falling due within a year, and liabilities of CN¥815.3m due beyond that. Offsetting this, it had CN¥773.3m in cash and CN¥859.0m in receivables that were due within 12 months. So it actually has CN¥46.2m more liquid assets than total liabilities.

This state of affairs indicates that Tibet GaoZheng Explosive's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥5.49b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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

Tibet GaoZheng Explosive's net debt of 1.7 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 9.1 times interest expense) certainly does not do anything to dispel this impression. It is well worth noting that Tibet GaoZheng Explosive's EBIT shot up like bamboo after rain, gaining 65% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tibet GaoZheng Explosive will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Tibet GaoZheng Explosive burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Tibet GaoZheng Explosive's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Tibet GaoZheng Explosive can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Tibet GaoZheng Explosive 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.