Grandtop Yongxing GroupLtd (SHSE:601033) Takes On Some Risk With Its Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Grandtop Yongxing Group Co.,Ltd (SHSE:601033) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Grandtop Yongxing GroupLtd

What Is Grandtop Yongxing GroupLtd's Debt?

The chart below, which you can click on for greater detail, shows that Grandtop Yongxing GroupLtd had CN¥12.2b in debt in March 2024; about the same as the year before. On the flip side, it has CN¥3.25b in cash leading to net debt of about CN¥8.95b.

How Healthy Is Grandtop Yongxing GroupLtd's Balance Sheet?

The latest balance sheet data shows that Grandtop Yongxing GroupLtd had liabilities of CN¥5.47b due within a year, and liabilities of CN¥10.3b falling due after that. Offsetting this, it had CN¥3.25b in cash and CN¥1.85b in receivables that were due within 12 months. So its liabilities total CN¥10.6b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥14.8b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Grandtop Yongxing GroupLtd has a debt to EBITDA ratio of 4.6 and its EBIT covered its interest expense 3.4 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. However, one redeeming factor is that Grandtop Yongxing GroupLtd grew its EBIT at 14% over the last 12 months, boosting its ability to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Grandtop Yongxing GroupLtd's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Grandtop Yongxing GroupLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We'd go so far as to say Grandtop Yongxing GroupLtd's conversion of EBIT to free cash flow was disappointing. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Grandtop Yongxing GroupLtd has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Grandtop Yongxing GroupLtd (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com