Is GuangDong ShaoNeng Group (SZSE:000601) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that GuangDong ShaoNeng Group Co., Ltd. (SZSE:000601) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for GuangDong ShaoNeng Group

What Is GuangDong ShaoNeng Group's Debt?

As you can see below, GuangDong ShaoNeng Group had CN¥6.53b of debt at September 2024, down from CN¥7.17b a year prior. However, it does have CN¥404.8m in cash offsetting this, leading to net debt of about CN¥6.13b.

How Strong Is GuangDong ShaoNeng Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that GuangDong ShaoNeng Group had liabilities of CN¥2.55b due within 12 months and liabilities of CN¥5.42b due beyond that. On the other hand, it had cash of CN¥404.8m and CN¥2.01b worth of receivables due within a year. So its liabilities total CN¥5.56b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥4.83b, we think shareholders really should watch GuangDong ShaoNeng Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.67 times and a disturbingly high net debt to EBITDA ratio of 7.4 hit our confidence in GuangDong ShaoNeng Group like a one-two punch to the gut. The debt burden here is substantial. The silver lining is that GuangDong ShaoNeng Group grew its EBIT by 187% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. There's no doubt that we learn most about debt from the balance sheet. But it is GuangDong ShaoNeng Group'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.

Finally, while the tax-man may adore accounting profits, lenders only accept 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, GuangDong ShaoNeng Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

While GuangDong ShaoNeng Group's interest cover has us nervous. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that GuangDong ShaoNeng Group is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for GuangDong ShaoNeng Group 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.