These 4 Measures Indicate That Great Wall Motor (HKG:2333) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Great Wall Motor Company Limited (HKG:2333) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Great Wall Motor

How Much Debt Does Great Wall Motor Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Great Wall Motor had CN¥29.3b of debt, an increase on CN¥20.9b, over one year. However, it does have CN¥44.7b in cash offsetting this, leading to net cash of CN¥15.4b.

A Look At Great Wall Motor's Liabilities

We can see from the most recent balance sheet that Great Wall Motor had liabilities of CN¥95.8b falling due within a year, and liabilities of CN¥24.3b due beyond that. Offsetting these obligations, it had cash of CN¥44.7b as well as receivables valued at CN¥35.8b due within 12 months. So its liabilities total CN¥39.6b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Great Wall Motor is worth a massive CN¥185.2b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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 good news is that Great Wall Motor has increased its EBIT by 9.6% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Great Wall Motor 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. Over the last three years, Great Wall Motor actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

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¥15.4b. And it impressed us with free cash flow of -CN¥4.0b, being 127% of its EBIT. So we don't think Great Wall Motor's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Great Wall Motor (of which 1 doesn't sit too well with us!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.