Is Geely Automobile Holdings (HKG:175) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Geely Automobile Holdings Limited (HKG:175) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Geely Automobile Holdings

What Is Geely Automobile Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Geely Automobile Holdings had CN¥12.4b of debt, an increase on CN¥3.87b, over one year. However, its balance sheet shows it holds CN¥37.6b in cash, so it actually has CN¥25.1b net cash.

How Healthy Is Geely Automobile Holdings' Balance Sheet?

We can see from the most recent balance sheet that Geely Automobile Holdings had liabilities of CN¥58.7b falling due within a year, and liabilities of CN¥9.55b due beyond that. Offsetting these obligations, it had cash of CN¥37.6b as well as receivables valued at CN¥22.3b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥8.36b.

Given Geely Automobile Holdings has a humongous market capitalization of CN¥152.2b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Geely Automobile Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Geely Automobile Holdings's load is not too heavy, because its EBIT was down 96% 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 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Over the last three years, Geely Automobile Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

We could understand if investors are concerned about Geely Automobile Holdings's liabilities, but we can be reassured by the fact it has has net cash of CN¥25.1b. And it impressed us with free cash flow of CN¥14b, being 151% of its EBIT. So we are not troubled with Geely Automobile Holdings'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. We've identified 2 warning signs with Geely Automobile Holdings , and understanding them should be part of your investment process.

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.