Is Giant Network Group (SZSE:002558) A Risky Investment?

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. Importantly, Giant Network Group Co., Ltd. (SZSE:002558) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 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 Giant Network Group

What Is Giant Network Group's Net Debt?

As you can see below, Giant Network Group had CN¥482.6m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥2.33b in cash to offset that, meaning it has CN¥1.85b net cash.

How Healthy Is Giant Network Group's Balance Sheet?

According to the last reported balance sheet, Giant Network Group had liabilities of CN¥1.59b due within 12 months, and liabilities of CN¥67.8m due beyond 12 months. On the other hand, it had cash of CN¥2.33b and CN¥179.1m worth of receivables due within a year. So it actually has CN¥854.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Giant Network Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Giant Network Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Giant Network Group has boosted its EBIT by 85%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Giant Network Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Giant Network Group 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, Giant Network Group 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 we empathize with investors who find debt concerning, you should keep in mind that Giant Network Group has net cash of CN¥1.85b, as well as more liquid assets than liabilities. The cherry on top was that in converted 116% of that EBIT to free cash flow, bringing in CN¥929m. So is Giant Network Group's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Giant Network Group has 1 warning sign we think 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.