Guangdong Dongpeng HoldingsLtd (SZSE:003012) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Guangdong Dongpeng Holdings Co.,Ltd. (SZSE:003012) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Guangdong Dongpeng HoldingsLtd

What Is Guangdong Dongpeng HoldingsLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Guangdong Dongpeng HoldingsLtd had CN¥380.0m of debt in September 2024, down from CN¥433.3m, one year before. However, its balance sheet shows it holds CN¥2.89b in cash, so it actually has CN¥2.51b net cash.

A Look At Guangdong Dongpeng HoldingsLtd's Liabilities

According to the last reported balance sheet, Guangdong Dongpeng HoldingsLtd had liabilities of CN¥4.00b due within 12 months, and liabilities of CN¥350.4m due beyond 12 months. Offsetting this, it had CN¥2.89b in cash and CN¥1.22b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥240.7m.

Since publicly traded Guangdong Dongpeng HoldingsLtd shares are worth a total of CN¥6.67b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Guangdong Dongpeng HoldingsLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Guangdong Dongpeng HoldingsLtd if management cannot prevent a repeat of the 41% cut to EBIT 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 Guangdong Dongpeng HoldingsLtd 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. Guangdong Dongpeng HoldingsLtd 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. Happily for any shareholders, Guangdong Dongpeng HoldingsLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Guangdong Dongpeng HoldingsLtd has CN¥2.51b in net cash. And it impressed us with free cash flow of CN¥615m, being 133% of its EBIT. So we are not troubled with Guangdong Dongpeng HoldingsLtd's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Guangdong Dongpeng HoldingsLtd is showing 1 warning sign in our investment analysis , you should know about...

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.