Guangdong Dowstone Technology (SZSE:300409) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Guangdong Dowstone Technology Co., Ltd. (SZSE:300409) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Guangdong Dowstone Technology

What Is Guangdong Dowstone Technology's Debt?

As you can see below, Guangdong Dowstone Technology had CN¥5.99b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥3.06b in cash offsetting this, leading to net debt of about CN¥2.93b.

How Strong Is Guangdong Dowstone Technology's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Dowstone Technology had liabilities of CN¥4.27b falling due within a year, and liabilities of CN¥3.66b due beyond that. Offsetting these obligations, it had cash of CN¥3.06b as well as receivables valued at CN¥1.93b due within 12 months. So its liabilities total CN¥2.94b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Guangdong Dowstone Technology has a market capitalization of CN¥9.09b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Guangdong Dowstone Technology has a debt to EBITDA ratio of 3.6 and its EBIT covered its interest expense 4.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. We also note that Guangdong Dowstone Technology improved its EBIT from a last year's loss to a positive CN¥361m. 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 Dowstone Technology'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Guangdong Dowstone Technology 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

Mulling over Guangdong Dowstone Technology's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least its EBIT growth rate is not so bad. Once we consider all the factors above, together, it seems to us that Guangdong Dowstone Technology's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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 Guangdong Dowstone Technology has 4 warning signs (and 2 which are concerning) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.