Is Gree Electric Appliances of Zhuhai (SZSE:000651) A Risky Investment?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Gree Electric Appliances, Inc. of Zhuhai (SZSE:000651) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Gree Electric Appliances of Zhuhai

What Is Gree Electric Appliances of Zhuhai's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Gree Electric Appliances of Zhuhai had debt of CN¥91.2b, up from CN¥85.0b in one year. However, its balance sheet shows it holds CN¥186.7b in cash, so it actually has CN¥95.5b net cash.

A Look At Gree Electric Appliances of Zhuhai's Liabilities

Zooming in on the latest balance sheet data, we can see that Gree Electric Appliances of Zhuhai had liabilities of CN¥220.6b due within 12 months and liabilities of CN¥48.5b due beyond that. Offsetting this, it had CN¥186.7b in cash and CN¥40.3b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥42.0b.

This deficit isn't so bad because Gree Electric Appliances of Zhuhai is worth a massive CN¥204.3b, and thus could probably raise enough capital to shore up 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. While it does have liabilities worth noting, Gree Electric Appliances of Zhuhai also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Gree Electric Appliances of Zhuhai saw its EBIT decline by 8.0% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Gree Electric Appliances of Zhuhai 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. While Gree Electric Appliances of Zhuhai 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, Gree Electric Appliances of Zhuhai recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While Gree Electric Appliances of Zhuhai does have more liabilities than liquid assets, it also has net cash of CN¥95.5b. And it impressed us with free cash flow of CN¥40b, being 94% of its EBIT. So we don't have any problem with Gree Electric Appliances of Zhuhai's use of debt. 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 example, we've discovered 1 warning sign for Gree Electric Appliances of Zhuhai that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.