Is Victory Giant Technology (HuiZhou)Co.Ltd (SZSE:300476) 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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Victory Giant Technology (HuiZhou)Co.,Ltd. (SZSE:300476) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

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

How Much Debt Does Victory Giant Technology (HuiZhou)Co.Ltd Carry?

As you can see below, at the end of March 2024, Victory Giant Technology (HuiZhou)Co.Ltd had CN¥4.54b of debt, up from CN¥3.81b a year ago. Click the image for more detail. However, it does have CN¥1.83b in cash offsetting this, leading to net debt of about CN¥2.71b.

How Strong Is Victory Giant Technology (HuiZhou)Co.Ltd's Balance Sheet?

According to the last reported balance sheet, Victory Giant Technology (HuiZhou)Co.Ltd had liabilities of CN¥7.10b due within 12 months, and liabilities of CN¥2.14b due beyond 12 months. Offsetting this, it had CN¥1.83b in cash and CN¥3.67b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.75b.

Of course, Victory Giant Technology (HuiZhou)Co.Ltd has a market capitalization of CN¥22.3b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Victory Giant Technology (HuiZhou)Co.Ltd's moderate net debt to EBITDA ratio ( being 1.9), indicates prudence when it comes to debt. And its commanding EBIT of 25.8 times its interest expense, implies the debt load is as light as a peacock feather. If Victory Giant Technology (HuiZhou)Co.Ltd can keep growing EBIT at last year's rate of 15% over the last year, then it will find its debt load easier to manage. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Victory Giant Technology (HuiZhou)Co.Ltd reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On our analysis Victory Giant Technology (HuiZhou)Co.Ltd's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that Victory Giant Technology (HuiZhou)Co.Ltd is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Victory Giant Technology (HuiZhou)Co.Ltd that you should be aware of.

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.