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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Guangzhou Zhiguang Electric Co.,Ltd. (SZSE:002169) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Guangzhou Zhiguang ElectricLtd's Debt?
The image below, which you can click on for greater detail, shows that at September 2024 Guangzhou Zhiguang ElectricLtd had debt of CN¥2.34b, up from CN¥1.67b in one year. However, it also had CN¥723.9m in cash, and so its net debt is CN¥1.62b.
How Healthy Is Guangzhou Zhiguang ElectricLtd's Balance Sheet?
According to the last reported balance sheet, Guangzhou Zhiguang ElectricLtd had liabilities of CN¥3.57b due within 12 months, and liabilities of CN¥1.92b due beyond 12 months. Offsetting these obligations, it had cash of CN¥723.9m as well as receivables valued at CN¥2.16b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.61b.
Guangzhou Zhiguang ElectricLtd has a market capitalization of CN¥4.87b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is Guangzhou Zhiguang ElectricLtd'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.
Over 12 months, Guangzhou Zhiguang ElectricLtd saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.
Caveat Emptor
Importantly, Guangzhou Zhiguang ElectricLtd had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥73m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥1.1b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. We've identified 3 warning signs with Guangzhou Zhiguang ElectricLtd , 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.
