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.' 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. Importantly, Great Wall Motor Company Limited (HKG:2333) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Great Wall Motor
How Much Debt Does Great Wall Motor Carry?
The image below, which you can click on for greater detail, shows that at June 2022 Great Wall Motor had debt of CN¥28.4b, up from CN¥21.1b in one year. But on the other hand it also has CN¥54.8b in cash, leading to a CN¥26.3b net cash position.
How Healthy Is Great Wall Motor's Balance Sheet?
The latest balance sheet data shows that Great Wall Motor had liabilities of CN¥90.4b due within a year, and liabilities of CN¥27.1b falling due after that. On the other hand, it had cash of CN¥54.8b and CN¥34.8b worth of receivables due within a year. So it has liabilities totalling CN¥27.9b more than its cash and near-term receivables, combined.
Of course, Great Wall Motor has a titanic market capitalization of CN¥225.4b, so these liabilities are probably manageable. 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, Great Wall Motor 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 Great Wall Motor if management cannot prevent a repeat of the 53% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Great Wall Motor can strengthen its balance sheet over time. 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. While Great Wall Motor 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. Happily for any shareholders, Great Wall Motor actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
Although Great Wall Motor's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥26.3b. And it impressed us with free cash flow of CN¥12b, being 203% of its EBIT. So we don't have any problem with Great Wall Motor's use of debt. 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 - Great Wall Motor has 1 warning sign we think you should be aware of.
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.
About SEHK:2333
Great Wall Motor
Researches and develops, manufactures, and sells automobiles, and automotive parts and components in China, Europe, ASEAN countries, Latin America, the Middle East, Australia, South Africa, and internationally.
Undervalued with solid track record.