Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Gongniu Group Co.,Ltd. (SHSE:603195) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Gongniu GroupLtd
What Is Gongniu GroupLtd's Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Gongniu GroupLtd had debt of CN¥1.10b, up from CN¥879.4m in one year. But it also has CN¥15.9b in cash to offset that, meaning it has CN¥14.8b net cash.
How Healthy Is Gongniu GroupLtd's Balance Sheet?
According to the last reported balance sheet, Gongniu GroupLtd had liabilities of CN¥5.63b due within 12 months, and liabilities of CN¥237.0m due beyond 12 months. On the other hand, it had cash of CN¥15.9b and CN¥348.9m worth of receivables due within a year. So it actually has CN¥10.4b more liquid assets than total liabilities.
This short term liquidity is a sign that Gongniu GroupLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Gongniu GroupLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
Another good sign is that Gongniu GroupLtd has been able to increase its EBIT by 29% in twelve months, making it easier to pay down debt. 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 Gongniu GroupLtd 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. Gongniu GroupLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Gongniu GroupLtd generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Gongniu GroupLtd has net cash of CN¥14.8b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥4.2b, being 89% of its EBIT. So we don't think Gongniu GroupLtd's use of debt is 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. For instance, we've identified 1 warning sign for Gongniu GroupLtd that you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com
About SHSE:603195
Undervalued with solid track record.
