We Think Geely Automobile Holdings (HKG:175) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Geely Automobile Holdings Limited (HKG:175) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that 175 is potentially undervalued!

What Is Geely Automobile Holdings's 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, it does have CN¥37.6b in cash offsetting this, leading to net cash of CN¥25.1b.

A Look At Geely Automobile Holdings' Liabilities

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 this, it had CN¥37.6b in cash and CN¥22.3b in receivables that were due within 12 months. So its liabilities total CN¥8.36b more than the combination of its cash and short-term receivables.

Of course, Geely Automobile Holdings has a titanic market capitalization of CN¥89.2b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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.

The modesty of its debt load may become crucial for Geely Automobile Holdings if management cannot prevent a repeat of the 96% 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. 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 Geely Automobile Holdings'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Geely Automobile Holdings 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, Geely Automobile Holdings 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 Geely Automobile Holdings has CN¥25.1b in net cash. And it impressed us with free cash flow of CN¥14b, being 151% of its EBIT. So we don't have any problem with Geely Automobile Holdings's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Geely Automobile Holdings that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.