Is Guangxi Guiguan Electric PowerCo.Ltd (SHSE:600236) 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.' 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 Guangxi Guiguan Electric PowerCo.,Ltd. (SHSE:600236) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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

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

The image below, which you can click on for greater detail, shows that at June 2024 Guangxi Guiguan Electric PowerCo.Ltd had debt of CN¥22.4b, up from CN¥20.6b in one year. However, it also had CN¥1.42b in cash, and so its net debt is CN¥21.0b.

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

According to the last reported balance sheet, Guangxi Guiguan Electric PowerCo.Ltd had liabilities of CN¥15.7b due within 12 months, and liabilities of CN¥10.1b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.42b as well as receivables valued at CN¥2.39b due within 12 months. So its liabilities total CN¥22.0b more than the combination of its cash and short-term receivables.

Guangxi Guiguan Electric PowerCo.Ltd has a market capitalization of CN¥49.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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

Guangxi Guiguan Electric PowerCo.Ltd has a debt to EBITDA ratio of 4.2 and its EBIT covered its interest expense 5.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The bad news is that Guangxi Guiguan Electric PowerCo.Ltd saw its EBIT decline by 12% 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. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Guangxi Guiguan Electric PowerCo.Ltd produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Both Guangxi Guiguan Electric PowerCo.Ltd's EBIT growth rate and its net debt to EBITDA were discouraging. At least its conversion of EBIT to free cash flow gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Guangxi Guiguan Electric PowerCo.Ltd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. We've identified 2 warning signs with Guangxi Guiguan Electric PowerCo.Ltd (at least 1 which is concerning) , and understanding them should be part of your investment process.

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.