Is Guangzhou Automobile Group (HKG:2238) Using Debt 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.' 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 Guangzhou Automobile Group Co., Ltd. (HKG:2238) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Guangzhou Automobile Group

What Is Guangzhou Automobile Group's Net Debt?

The chart below, which you can click on for greater detail, shows that Guangzhou Automobile Group had CN¥13.0b in debt in September 2020; about the same as the year before. However, it does have CN¥24.8b in cash offsetting this, leading to net cash of CN¥11.8b.

How Strong Is Guangzhou Automobile Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangzhou Automobile Group had liabilities of CN¥33.1b due within 12 months and liabilities of CN¥13.6b due beyond that. Offsetting these obligations, it had cash of CN¥24.8b as well as receivables valued at CN¥7.11b due within 12 months. So it has liabilities totalling CN¥14.8b more than its cash and near-term receivables, combined.

Since publicly traded Guangzhou Automobile Group shares are worth a very impressive total of CN¥112.8b, it seems unlikely that this level of liabilities would be a major 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, Guangzhou Automobile Group also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Guangzhou Automobile Group 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.

Over 12 months, Guangzhou Automobile Group made a loss at the EBIT level, and saw its revenue drop to CN¥60b, which is a fall of 3.3%. That's not what we would hope to see.

So How Risky Is Guangzhou Automobile Group?

While Guangzhou Automobile Group lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥5.3b. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. To that end, you should be aware of the 2 warning signs we've spotted with Guangzhou Automobile Group .

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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