Does CNGR Advanced MaterialLtd (SZSE:300919) Have A Healthy 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.' 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 CNGR Advanced Material Co.,Ltd. (SZSE:300919) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for CNGR Advanced MaterialLtd

What Is CNGR Advanced MaterialLtd's Debt?

As you can see below, at the end of June 2024, CNGR Advanced MaterialLtd had CN¥27.1b of debt, up from CN¥23.9b a year ago. Click the image for more detail. However, it also had CN¥12.7b in cash, and so its net debt is CN¥14.3b.

A Look At CNGR Advanced MaterialLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that CNGR Advanced MaterialLtd had liabilities of CN¥17.4b due within 12 months and liabilities of CN¥22.5b due beyond that. On the other hand, it had cash of CN¥12.7b and CN¥5.14b worth of receivables due within a year. So it has liabilities totalling CN¥22.0b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥26.5b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

CNGR Advanced MaterialLtd's net debt is 3.4 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 10.8 is very high, suggesting that the interest expense on the debt is currently quite low. Importantly, CNGR Advanced MaterialLtd grew its EBIT by 79% over the last twelve months, and that growth will make it easier to handle its debt. 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 CNGR Advanced MaterialLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, CNGR Advanced MaterialLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

While CNGR Advanced MaterialLtd's conversion of EBIT to free cash flow has us nervous. For example, its EBIT growth rate and interest cover give us some confidence in its ability to manage its debt. When we consider all the factors discussed, it seems to us that CNGR Advanced MaterialLtd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. We've identified 2 warning signs with CNGR Advanced MaterialLtd (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

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.