Here's Why Guangxi Guiguan Electric PowerCo.Ltd (SHSE:600236) Has A Meaningful Debt Burden

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.' 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. We can see that Guangxi Guiguan Electric PowerCo.,Ltd. (SHSE:600236) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Guangxi Guiguan Electric PowerCo.Ltd

What Is Guangxi Guiguan Electric PowerCo.Ltd's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Guangxi Guiguan Electric PowerCo.Ltd had debt of CN¥23.4b, up from CN¥19.5b in one year. However, because it has a cash reserve of CN¥1.89b, its net debt is less, at about CN¥21.5b.

A Look At Guangxi Guiguan Electric PowerCo.Ltd's Liabilities

We can see from the most recent balance sheet that Guangxi Guiguan Electric PowerCo.Ltd had liabilities of CN¥16.0b falling due within a year, and liabilities of CN¥10.7b due beyond that. On the other hand, it had cash of CN¥1.89b and CN¥1.97b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥22.9b.

Guangxi Guiguan Electric PowerCo.Ltd has a market capitalization of CN¥57.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 5.0, it's fair to say Guangxi Guiguan Electric PowerCo.Ltd does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 5.1 times, suggesting it can responsibly service its obligations. Importantly, Guangxi Guiguan Electric PowerCo.Ltd's EBIT fell a jaw-dropping 49% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Guangxi Guiguan Electric PowerCo.Ltd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Guangxi Guiguan Electric PowerCo.Ltd produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

To be frank both Guangxi Guiguan Electric PowerCo.Ltd's net debt to EBITDA and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Guangxi Guiguan Electric PowerCo.Ltd's debt is making it 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. 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. To that end, you should learn about the 3 warning signs we've spotted with Guangxi Guiguan Electric PowerCo.Ltd (including 2 which are potentially serious) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.