These 4 Measures Indicate That Weihai Guangwei Composites (SZSE:300699) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Weihai Guangwei Composites Co., Ltd. (SZSE:300699) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Weihai Guangwei Composites

What Is Weihai Guangwei Composites's Debt?

As you can see below, at the end of September 2024, Weihai Guangwei Composites had CN¥1.12b of debt, up from CN¥332.4m a year ago. Click the image for more detail. However, it does have CN¥694.4m in cash offsetting this, leading to net debt of about CN¥424.8m.

How Healthy Is Weihai Guangwei Composites' Balance Sheet?

We can see from the most recent balance sheet that Weihai Guangwei Composites had liabilities of CN¥1.12b falling due within a year, and liabilities of CN¥1.09b due beyond that. On the other hand, it had cash of CN¥694.4m and CN¥2.37b worth of receivables due within a year. So it can boast CN¥855.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Weihai Guangwei Composites could probably pay off its debt with ease, as its balance sheet is far from stretched.

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).

Weihai Guangwei Composites has a low net debt to EBITDA ratio of only 0.37. And its EBIT easily covers its interest expense, being 72.6 times the size. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Weihai Guangwei Composites grew its EBIT by 9.2% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Weihai Guangwei Composites can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Weihai Guangwei Composites recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Weihai Guangwei Composites's interest cover 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. Looking at all the aforementioned factors together, it strikes us that Weihai Guangwei Composites can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Weihai Guangwei Composites you should be aware of, and 1 of them is concerning.

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.