Geely Automobile Holdings (HKG:175) Seems To Use Debt Quite Sensibly

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.' 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 Geely Automobile Holdings Limited (HKG:175) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 Geely Automobile Holdings

How Much Debt Does Geely Automobile Holdings Carry?

The chart below, which you can click on for greater detail, shows that Geely Automobile Holdings had CN¥3.81b in debt in December 2021; about the same as the year before. However, it does have CN¥28.0b in cash offsetting this, leading to net cash of CN¥24.2b.

A Look At Geely Automobile Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Geely Automobile Holdings had liabilities of CN¥60.4b due within 12 months and liabilities of CN¥3.77b due beyond that. Offsetting these obligations, it had cash of CN¥28.0b as well as receivables valued at CN¥31.7b due within 12 months. So its liabilities total CN¥4.42b more than the combination of its cash and short-term receivables.

Given Geely Automobile Holdings has a humongous market capitalization of CN¥98.7b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Geely Automobile Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Geely Automobile Holdings's load is not too heavy, because its EBIT was down 53% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Geely Automobile Holdings's ability to maintain a healthy balance sheet going forward. 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. While Geely Automobile Holdings 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. During the last three years, Geely Automobile Holdings produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Geely Automobile Holdings has CN¥24.2b in net cash. And it impressed us with free cash flow of CN¥9.3b, being 67% of its EBIT. So we don't have any problem with Geely Automobile Holdings's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Geely Automobile Holdings has 2 warning signs 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.