Sichuan Guangan Aaa PublicLtd (SHSE:600979) Has A Pretty Healthy Balance Sheet

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. We note that Sichuan Guangan Aaa Public Co.,Ltd (SHSE:600979) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sichuan Guangan Aaa PublicLtd

What Is Sichuan Guangan Aaa PublicLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Sichuan Guangan Aaa PublicLtd had debt of CN¥3.15b, up from CN¥3.00b in one year. However, because it has a cash reserve of CN¥568.0m, its net debt is less, at about CN¥2.59b.

A Look At Sichuan Guangan Aaa PublicLtd's Liabilities

According to the last reported balance sheet, Sichuan Guangan Aaa PublicLtd had liabilities of CN¥1.99b due within 12 months, and liabilities of CN¥4.58b due beyond 12 months. Offsetting these obligations, it had cash of CN¥568.0m as well as receivables valued at CN¥773.8m due within 12 months. So its liabilities total CN¥5.22b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥5.39b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Sichuan Guangan Aaa PublicLtd's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 5.6 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, Sichuan Guangan Aaa PublicLtd grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sichuan Guangan Aaa PublicLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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, Sichuan Guangan Aaa PublicLtd recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

When it comes to the balance sheet, the standout positive for Sichuan Guangan Aaa PublicLtd was the fact that it seems able to grow its EBIT confidently. However, our other observations weren't so heartening. For example, its level of total liabilities makes us a little nervous about its debt. It's also worth noting that Sichuan Guangan Aaa PublicLtd is in the Electric Utilities industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about Sichuan Guangan Aaa PublicLtd's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Sichuan Guangan Aaa PublicLtd (of which 1 shouldn't be ignored!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.