Is Guangdong Senssun Weighing Apparatus Group (SZSE:002870) Using Too Much Debt?

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. As with many other companies Guangdong Senssun Weighing Apparatus Group Ltd. (SZSE:002870) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Guangdong Senssun Weighing Apparatus Group

What Is Guangdong Senssun Weighing Apparatus Group's Debt?

As you can see below, at the end of September 2024, Guangdong Senssun Weighing Apparatus Group had CN¥2.59b of debt, up from CN¥1.89b a year ago. Click the image for more detail. However, it does have CN¥1.11b in cash offsetting this, leading to net debt of about CN¥1.48b.

How Strong Is Guangdong Senssun Weighing Apparatus Group's Balance Sheet?

According to the last reported balance sheet, Guangdong Senssun Weighing Apparatus Group had liabilities of CN¥3.90b due within 12 months, and liabilities of CN¥1.57b due beyond 12 months. On the other hand, it had cash of CN¥1.11b and CN¥1.32b worth of receivables due within a year. So its liabilities total CN¥3.05b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥4.53b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

Guangdong Senssun Weighing Apparatus Group has net debt worth 2.3 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.6 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. The bad news is that Guangdong Senssun Weighing Apparatus Group saw its EBIT decline by 13% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. 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 Guangdong Senssun Weighing Apparatus Group'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.

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 that EBIT is backed by free cash flow. Looking at the most recent three years, Guangdong Senssun Weighing Apparatus Group recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say Guangdong Senssun Weighing Apparatus Group's EBIT growth rate was disappointing. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Guangdong Senssun Weighing Apparatus Group stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less 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. To that end, you should be aware of the 1 warning sign we've spotted with Guangdong Senssun Weighing Apparatus Group .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.