Guangdong Shunkong DevelopmentLtd (SZSE:003039) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Guangdong Shunkong Development Co.,Ltd. (SZSE:003039) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Guangdong Shunkong DevelopmentLtd

What Is Guangdong Shunkong DevelopmentLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Guangdong Shunkong DevelopmentLtd had CN¥1.91b of debt, an increase on CN¥636.6m, over one year. On the flip side, it has CN¥835.9m in cash leading to net debt of about CN¥1.07b.

How Healthy Is Guangdong Shunkong DevelopmentLtd's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Shunkong DevelopmentLtd had liabilities of CN¥1.27b falling due within a year, and liabilities of CN¥1.71b due beyond that. On the other hand, it had cash of CN¥835.9m and CN¥764.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.38b.

Guangdong Shunkong DevelopmentLtd has a market capitalization of CN¥6.89b, 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.

Guangdong Shunkong DevelopmentLtd has a low net debt to EBITDA ratio of only 1.3. And its EBIT covers its interest expense a whopping 17.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Guangdong Shunkong DevelopmentLtd has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Guangdong Shunkong DevelopmentLtd 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Guangdong Shunkong DevelopmentLtd recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Guangdong Shunkong DevelopmentLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! We would also note that Water Utilities industry companies like Guangdong Shunkong DevelopmentLtd commonly do use debt without problems. Zooming out, Guangdong Shunkong DevelopmentLtd seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. To that end, you should learn about the 2 warning signs we've spotted with Guangdong Shunkong DevelopmentLtd (including 1 which is potentially serious) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.