Is Avary Holding(Shenzhen)Co (SZSE:002938) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Avary Holding(Shenzhen)Co., Limited (SZSE:002938) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. 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.

See our latest analysis for Avary Holding(Shenzhen)Co

What Is Avary Holding(Shenzhen)Co's Net Debt?

As you can see below, Avary Holding(Shenzhen)Co had CN¥3.68b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥10.2b in cash offsetting this, leading to net cash of CN¥6.55b.

How Healthy Is Avary Holding(Shenzhen)Co's Balance Sheet?

According to the last reported balance sheet, Avary Holding(Shenzhen)Co had liabilities of CN¥12.5b due within 12 months, and liabilities of CN¥986.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥10.2b as well as receivables valued at CN¥7.04b due within 12 months. So it actually has CN¥3.84b more liquid assets than total liabilities.

This surplus suggests that Avary Holding(Shenzhen)Co has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Avary Holding(Shenzhen)Co has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Avary Holding(Shenzhen)Co has seen its EBIT plunge 12% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Avary Holding(Shenzhen)Co can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Avary Holding(Shenzhen)Co has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Avary Holding(Shenzhen)Co actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Avary Holding(Shenzhen)Co has net cash of CN¥6.55b, as well as more liquid assets than liabilities. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in CN¥2.9b. So is Avary Holding(Shenzhen)Co's debt a risk? It doesn't seem so to us. 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. For example - Avary Holding(Shenzhen)Co has 1 warning sign we think you should be aware of.

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.