Is Guangzhou Shiyuan Electronic Technology (SZSE:002841) A Risky Investment?

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.' 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, Guangzhou Shiyuan Electronic Technology Company Limited (SZSE:002841) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Guangzhou Shiyuan Electronic Technology

What Is Guangzhou Shiyuan Electronic Technology's Debt?

As you can see below, at the end of September 2024, Guangzhou Shiyuan Electronic Technology had CN¥3.50b of debt, up from CN¥2.81b a year ago. Click the image for more detail. But on the other hand it also has CN¥4.46b in cash, leading to a CN¥958.9m net cash position.

How Healthy Is Guangzhou Shiyuan Electronic Technology's Balance Sheet?

The latest balance sheet data shows that Guangzhou Shiyuan Electronic Technology had liabilities of CN¥9.16b due within a year, and liabilities of CN¥941.9m falling due after that. Offsetting this, it had CN¥4.46b in cash and CN¥765.4m in receivables that were due within 12 months. So its liabilities total CN¥4.87b more than the combination of its cash and short-term receivables.

Given Guangzhou Shiyuan Electronic Technology has a market capitalization of CN¥26.3b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Guangzhou Shiyuan Electronic Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Guangzhou Shiyuan Electronic Technology's EBIT dived 12%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Guangzhou Shiyuan Electronic Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Guangzhou Shiyuan Electronic Technology 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. In the last three years, Guangzhou Shiyuan Electronic Technology's free cash flow amounted to 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Guangzhou Shiyuan Electronic Technology's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥958.9m. So we don't have any problem with Guangzhou Shiyuan Electronic Technology's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Guangzhou Shiyuan Electronic Technology has 2 warning signs (and 1 which is potentially serious) we think you should know about.

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.