Does Guangdong Enpack Packaging (SZSE:002846) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Guangdong Enpack Packaging Co., Ltd. (SZSE:002846) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Guangdong Enpack Packaging

What Is Guangdong Enpack Packaging's Net Debt?

As you can see below, at the end of September 2024, Guangdong Enpack Packaging had CN¥1.14b of debt, up from CN¥881.5m a year ago. Click the image for more detail. However, it also had CN¥102.9m in cash, and so its net debt is CN¥1.03b.

A Look At Guangdong Enpack Packaging's Liabilities

According to the last reported balance sheet, Guangdong Enpack Packaging had liabilities of CN¥1.45b due within 12 months, and liabilities of CN¥504.5m due beyond 12 months. On the other hand, it had cash of CN¥102.9m and CN¥459.5m worth of receivables due within a year. So it has liabilities totalling CN¥1.39b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Guangdong Enpack Packaging is worth CN¥4.40b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.59 times and a disturbingly high net debt to EBITDA ratio of 7.6 hit our confidence in Guangdong Enpack Packaging like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, it should be some comfort for shareholders to recall that Guangdong Enpack Packaging actually grew its EBIT by a hefty 149%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Guangdong Enpack Packaging 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last two years, Guangdong Enpack Packaging saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Guangdong Enpack Packaging's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Guangdong Enpack Packaging stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Guangdong Enpack Packaging (2 make us uncomfortable) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.