Is Guangdong Fenghua Advanced Technology (Holding) (SZSE:000636) Using Too Much 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Guangdong Fenghua Advanced Technology (Holding) Co., Ltd. (SZSE:000636) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Guangdong Fenghua Advanced Technology (Holding)

What Is Guangdong Fenghua Advanced Technology (Holding)'s Debt?

As you can see below, Guangdong Fenghua Advanced Technology (Holding) had CN¥447.0m of debt at March 2024, down from CN¥1.19b a year prior. But it also has CN¥4.31b in cash to offset that, meaning it has CN¥3.87b net cash.

How Strong Is Guangdong Fenghua Advanced Technology (Holding)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangdong Fenghua Advanced Technology (Holding) had liabilities of CN¥2.64b due within 12 months and liabilities of CN¥787.2m due beyond that. Offsetting this, it had CN¥4.31b in cash and CN¥1.95b in receivables that were due within 12 months. So it can boast CN¥2.83b more liquid assets than total liabilities.

This excess liquidity suggests that Guangdong Fenghua Advanced Technology (Holding) is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Guangdong Fenghua Advanced Technology (Holding) boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Guangdong Fenghua Advanced Technology (Holding) made a loss at the EBIT level, last year, it was also good to see that it generated CN¥39m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Guangdong Fenghua Advanced Technology (Holding) 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Guangdong Fenghua Advanced Technology (Holding) may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Guangdong Fenghua Advanced Technology (Holding) actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangdong Fenghua Advanced Technology (Holding) has CN¥3.87b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥65m, being 168% of its EBIT. So is Guangdong Fenghua Advanced Technology (Holding)'s debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Guangdong Fenghua Advanced Technology (Holding), you may well want to click here to check an interactive graph of its earnings per share history.

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.

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