Does GalaxyCore (SHSE:688728) Have A Healthy Balance Sheet?

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.' 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 GalaxyCore Inc. (SHSE:688728) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for GalaxyCore

How Much Debt Does GalaxyCore Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 GalaxyCore had CN¥12.0b of debt, an increase on CN¥10.1b, over one year. However, it also had CN¥4.18b in cash, and so its net debt is CN¥7.78b.

How Strong Is GalaxyCore's Balance Sheet?

The latest balance sheet data shows that GalaxyCore had liabilities of CN¥8.38b due within a year, and liabilities of CN¥5.91b falling due after that. On the other hand, it had cash of CN¥4.18b and CN¥660.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥9.45b.

While this might seem like a lot, it is not so bad since GalaxyCore has a market capitalization of CN¥42.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

GalaxyCore shareholders face the double whammy of a high net debt to EBITDA ratio (7.9), and fairly weak interest coverage, since EBIT is just 0.75 times the interest expense. The debt burden here is substantial. However, the silver lining was that GalaxyCore achieved a positive EBIT of CN¥175m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine GalaxyCore's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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, GalaxyCore 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

On the face of it, GalaxyCore's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to handle its total liabilities isn't such a worry. Overall, we think it's fair to say that GalaxyCore has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. Be aware that GalaxyCore is showing 3 warning signs in our investment analysis , and 1 of those is concerning...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.