Is G & M Holdings (HKG:6038) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that G & M Holdings Limited (HKG:6038) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for G & M Holdings

How Much Debt Does G & M Holdings Carry?

As you can see below, at the end of December 2021, G & M Holdings had HK$15.9m of debt, up from HK$1.13m a year ago. Click the image for more detail. But it also has HK$114.8m in cash to offset that, meaning it has HK$98.9m net cash.

How Healthy Is G & M Holdings' Balance Sheet?

The latest balance sheet data shows that G & M Holdings had liabilities of HK$142.9m due within a year, and liabilities of HK$8.32m falling due after that. Offsetting these obligations, it had cash of HK$114.8m as well as receivables valued at HK$268.7m due within 12 months. So it actually has HK$232.3m more liquid assets than total liabilities.

This luscious liquidity implies that G & M Holdings' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that G & M Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, G & M Holdings grew its EBIT by 87% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is G & M Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. G & M 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. In the last three years, G & M Holdings's free cash flow amounted to 41% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, the bottom line is that G & M Holdings has net cash of HK$98.9m and plenty of liquid assets. And we liked the look of last year's 87% year-on-year EBIT growth. So we don't think G & M Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for G & M Holdings (of which 2 shouldn't be ignored!) you should know about.

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.