Here's Why Victory Giant Technology (HuiZhou)Co.Ltd (SZSE:300476) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Victory Giant Technology (HuiZhou)Co.,Ltd. (SZSE:300476) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Victory Giant Technology (HuiZhou)Co.Ltd

What Is Victory Giant Technology (HuiZhou)Co.Ltd's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Victory Giant Technology (HuiZhou)Co.Ltd had debt of CN¥4.25b, up from CN¥3.96b in one year. However, it also had CN¥1.84b in cash, and so its net debt is CN¥2.41b.

A Look At Victory Giant Technology (HuiZhou)Co.Ltd's Liabilities

We can see from the most recent balance sheet that Victory Giant Technology (HuiZhou)Co.Ltd had liabilities of CN¥6.95b falling due within a year, and liabilities of CN¥2.26b due beyond that. Offsetting these obligations, it had cash of CN¥1.84b as well as receivables valued at CN¥3.53b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.84b.

Of course, Victory Giant Technology (HuiZhou)Co.Ltd has a market capitalization of CN¥23.2b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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).

Victory Giant Technology (HuiZhou)Co.Ltd's net debt is only 1.4 times its EBITDA. And its EBIT covers its interest expense a whopping 18.3 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Victory Giant Technology (HuiZhou)Co.Ltd has boosted its EBIT by 53%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Victory Giant Technology (HuiZhou)Co.Ltd'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Victory Giant Technology (HuiZhou)Co.Ltd recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Victory Giant Technology (HuiZhou)Co.Ltd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Taking all this data into account, it seems to us that Victory Giant Technology (HuiZhou)Co.Ltd takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. We've identified 1 warning sign with Victory Giant Technology (HuiZhou)Co.Ltd , and understanding them should be part of your investment process.

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.