Guangdong Dowstone Technology (SZSE:300409) Takes On Some Risk With Its Use Of Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Guangdong Dowstone Technology Co., Ltd. (SZSE:300409) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 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.

View our latest analysis for Guangdong Dowstone Technology

What Is Guangdong Dowstone Technology's Debt?

As you can see below, Guangdong Dowstone Technology had CN¥5.81b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥3.45b in cash leading to net debt of about CN¥2.36b.

How Strong Is Guangdong Dowstone Technology's Balance Sheet?

The latest balance sheet data shows that Guangdong Dowstone Technology had liabilities of CN¥4.35b due within a year, and liabilities of CN¥3.52b falling due after that. On the other hand, it had cash of CN¥3.45b and CN¥2.08b worth of receivables due within a year. So it has liabilities totalling CN¥2.34b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Guangdong Dowstone Technology has a market capitalization of CN¥5.55b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Guangdong Dowstone Technology's debt is 3.2 times its EBITDA, and its EBIT cover its interest expense 3.8 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. One redeeming factor for Guangdong Dowstone Technology is that it turned last year's EBIT loss into a gain of CN¥373m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Guangdong Dowstone Technology 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Guangdong Dowstone Technology 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

We'd go so far as to say Guangdong Dowstone Technology's conversion of EBIT to free cash flow was disappointing. Having said that, its ability to grow its EBIT isn't such a worry. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Guangdong Dowstone Technology that you should be aware of before investing here.

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.