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. We can see that Guizhou Zhenhua Fengguang Semiconductor Co., Ltd. (SHSE:688439) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. 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. 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.
How Much Debt Does Guizhou Zhenhua Fengguang Semiconductor Carry?
As you can see below, Guizhou Zhenhua Fengguang Semiconductor had CN¥84.8m of debt at March 2024, down from CN¥105.2m a year prior. However, it does have CN¥2.38b in cash offsetting this, leading to net cash of CN¥2.30b.
How Healthy Is Guizhou Zhenhua Fengguang Semiconductor's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Guizhou Zhenhua Fengguang Semiconductor had liabilities of CN¥542.5m due within 12 months and liabilities of CN¥115.7m due beyond that. Offsetting these obligations, it had cash of CN¥2.38b as well as receivables valued at CN¥1.74b due within 12 months. So it can boast CN¥3.46b more liquid assets than total liabilities.
It's good to see that Guizhou Zhenhua Fengguang Semiconductor has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Guizhou Zhenhua Fengguang Semiconductor has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Guizhou Zhenhua Fengguang Semiconductor has boosted its EBIT by 54%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Guizhou Zhenhua Fengguang Semiconductor can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Guizhou Zhenhua Fengguang Semiconductor has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Guizhou Zhenhua Fengguang Semiconductor saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Guizhou Zhenhua Fengguang Semiconductor has net cash of CN¥2.30b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 54% over the last year. So is Guizhou Zhenhua Fengguang Semiconductor's debt a risk? It doesn't seem so to us. 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. To that end, you should learn about the 2 warning signs we've spotted with Guizhou Zhenhua Fengguang Semiconductor (including 1 which can't be ignored) .
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
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