Does Grandtop Yongxing GroupLtd (SHSE:601033) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Grandtop Yongxing Group Co.,Ltd (SHSE:601033) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Grandtop Yongxing GroupLtd

What Is Grandtop Yongxing GroupLtd's Net Debt?

As you can see below, at the end of September 2024, Grandtop Yongxing GroupLtd had CN¥10.8b of debt, up from CN¥9.88b a year ago. Click the image for more detail. On the flip side, it has CN¥1.97b in cash leading to net debt of about CN¥8.86b.

A Look At Grandtop Yongxing GroupLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Grandtop Yongxing GroupLtd had liabilities of CN¥4.97b due within 12 months and liabilities of CN¥9.25b due beyond that. Offsetting this, it had CN¥1.97b in cash and CN¥2.22b in receivables that were due within 12 months. So it has liabilities totalling CN¥10.0b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥13.5b. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Grandtop Yongxing GroupLtd has a debt to EBITDA ratio of 4.2 and its EBIT covered its interest expense 4.1 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The good news is that Grandtop Yongxing GroupLtd improved its EBIT by 5.6% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Grandtop Yongxing GroupLtd'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 it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, Grandtop Yongxing GroupLtd actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

We'd go so far as to say Grandtop Yongxing GroupLtd's conversion of EBIT to free cash flow was disappointing. But at least its EBIT growth rate is not so bad. Looking at the bigger picture, it seems clear to us that Grandtop Yongxing GroupLtd's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. There's no doubt that we learn most about debt from the balance sheet. 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 1 warning sign for Grandtop Yongxing GroupLtd you should know about.

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.