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.' 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 Guangzhou Guanggang Gases & Energy Co.,Ltd. (SHSE:688548) makes use of debt. But the more important question is: how much risk is that debt creating?
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. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Guangzhou Guanggang Gases & EnergyLtd Carry?
You can click the graphic below for the historical numbers, but it shows that Guangzhou Guanggang Gases & EnergyLtd had CN¥907.0m of debt in June 2024, down from CN¥1.08b, one year before. However, it does have CN¥1.93b in cash offsetting this, leading to net cash of CN¥1.02b.
How Strong Is Guangzhou Guanggang Gases & EnergyLtd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Guangzhou Guanggang Gases & EnergyLtd had liabilities of CN¥1.20b due within 12 months and liabilities of CN¥679.4m due beyond that. On the other hand, it had cash of CN¥1.93b and CN¥465.1m worth of receivables due within a year. So it actually has CN¥516.2m more liquid assets than total liabilities.
This surplus suggests that Guangzhou Guanggang Gases & EnergyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Guangzhou Guanggang Gases & EnergyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Guangzhou Guanggang Gases & EnergyLtd's load is not too heavy, because its EBIT was down 33% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Guangzhou Guanggang Gases & EnergyLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Guangzhou Guanggang Gases & EnergyLtd 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, Guangzhou Guanggang Gases & EnergyLtd 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 it is always sensible to investigate a company's debt, in this case Guangzhou Guanggang Gases & EnergyLtd has CN¥1.02b in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Guangzhou Guanggang Gases & EnergyLtd's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Guangzhou Guanggang Gases & EnergyLtd is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
