Is GRG Metrology & Test Group (SZSE:002967) Using Too Much Debt?

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 GRG Metrology & Test Group Co., Ltd. (SZSE:002967) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for GRG Metrology & Test Group

What Is GRG Metrology & Test Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 GRG Metrology & Test Group had CN¥1.39b of debt, an increase on CN¥1.21b, over one year. However, it also had CN¥1.03b in cash, and so its net debt is CN¥354.2m.

A Look At GRG Metrology & Test Group's Liabilities

Zooming in on the latest balance sheet data, we can see that GRG Metrology & Test Group had liabilities of CN¥1.64b due within 12 months and liabilities of CN¥934.2m due beyond that. Offsetting this, it had CN¥1.03b in cash and CN¥1.82b in receivables that were due within 12 months. So it can boast CN¥280.4m more liquid assets than total liabilities.

This short term liquidity is a sign that GRG Metrology & Test Group could probably pay off its debt with ease, as its balance sheet is far from stretched.

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.

GRG Metrology & Test Group's net debt is only 0.74 times its EBITDA. And its EBIT covers its interest expense a whopping 27.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that GRG Metrology & Test Group grew its EBIT at 11% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if GRG Metrology & Test Group 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, GRG Metrology & Test Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

GRG Metrology & Test Group's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that GRG Metrology & Test Group is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 GRG Metrology & Test Group is showing 1 warning sign in our investment analysis , you should know about...

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.