WG TECH (Jiang Xi) (SHSE:603773) Takes On Some Risk With Its Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies WG TECH (Jiang Xi) Co., Ltd. (SHSE:603773) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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.

Check out our latest analysis for WG TECH (Jiang Xi)

What Is WG TECH (Jiang Xi)'s Debt?

As you can see below, at the end of September 2024, WG TECH (Jiang Xi) had CN¥1.54b of debt, up from CN¥1.22b a year ago. Click the image for more detail. However, it does have CN¥871.8m in cash offsetting this, leading to net debt of about CN¥664.4m.

A Look At WG TECH (Jiang Xi)'s Liabilities

According to the last reported balance sheet, WG TECH (Jiang Xi) had liabilities of CN¥1.89b due within 12 months, and liabilities of CN¥1.02b due beyond 12 months. Offsetting these obligations, it had cash of CN¥871.8m as well as receivables valued at CN¥1.09b due within 12 months. So it has liabilities totalling CN¥945.4m more than its cash and near-term receivables, combined.

Given WG TECH (Jiang Xi) has a market capitalization of CN¥5.72b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Weak interest cover of 0.37 times and a disturbingly high net debt to EBITDA ratio of 5.4 hit our confidence in WG TECH (Jiang Xi) like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that WG TECH (Jiang Xi) achieved a positive EBIT of CN¥13m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if WG TECH (Jiang Xi) 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, 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. Over the last year, WG TECH (Jiang Xi) 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, WG TECH (Jiang Xi)'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. But at least its level of total liabilities is not so bad. Looking at the bigger picture, it seems clear to us that WG TECH (Jiang Xi)'s use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 1 warning sign for WG TECH (Jiang Xi) that you should be aware of before investing here.

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.