Health Check: How Prudently Does Goodbaby International Holdings (HKG:1086) Use 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. We can see that Goodbaby International Holdings Limited (HKG:1086) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out the opportunities and risks within the HK Leisure industry.

What Is Goodbaby International Holdings's Debt?

As you can see below, at the end of June 2022, Goodbaby International Holdings had HK$3.62b of debt, up from HK$2.91b a year ago. Click the image for more detail. However, it also had HK$842.1m in cash, and so its net debt is HK$2.78b.

A Look At Goodbaby International Holdings' Liabilities

According to the last reported balance sheet, Goodbaby International Holdings had liabilities of HK$3.56b due within 12 months, and liabilities of HK$2.96b due beyond 12 months. Offsetting these obligations, it had cash of HK$842.1m as well as receivables valued at HK$1.23b due within 12 months. So its liabilities total HK$4.44b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$1.17b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Goodbaby International Holdings would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Goodbaby International Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Goodbaby International Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 2.4%, to HK$9.4b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Goodbaby International Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost HK$66m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely, given it is low on liquid assets, and burned through HK$199m in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Goodbaby International Holdings (1 is a bit unpleasant!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.