Here's Why Guangdong Highsun GroupLtd (SZSE:000861) Has A Meaningful Debt Burden

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Guangdong Highsun Group Co.,Ltd. (SZSE:000861) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Guangdong Highsun GroupLtd

How Much Debt Does Guangdong Highsun GroupLtd Carry?

You can click the graphic below for the historical numbers, but it shows that Guangdong Highsun GroupLtd had CN¥3.34b of debt in March 2024, down from CN¥3.59b, one year before. However, it does have CN¥96.6m in cash offsetting this, leading to net debt of about CN¥3.24b.

How Strong Is Guangdong Highsun GroupLtd's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Highsun GroupLtd had liabilities of CN¥2.33b falling due within a year, and liabilities of CN¥2.55b due beyond that. On the other hand, it had cash of CN¥96.6m and CN¥182.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.61b.

Given this deficit is actually higher than the company's market capitalization of CN¥3.64b, we think shareholders really should watch Guangdong Highsun GroupLtd's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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 0.55 times and a disturbingly high net debt to EBITDA ratio of 17.7 hit our confidence in Guangdong Highsun GroupLtd like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Guangdong Highsun GroupLtd is that it turned last year's EBIT loss into a gain of CN¥101m, 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 Highsun GroupLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Guangdong Highsun GroupLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both Guangdong Highsun GroupLtd's net debt to EBITDA and its track record of covering its interest expense with its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Guangdong Highsun GroupLtd's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. We've identified 3 warning signs with Guangdong Highsun GroupLtd (at least 2 which don't sit too well with us) , 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.