Grace Wine Holdings (HKG:8146) Has A Pretty Healthy Balance Sheet

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. Importantly, Grace Wine Holdings Limited (HKG:8146) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Grace Wine Holdings

What Is Grace Wine Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Grace Wine Holdings had debt of CN¥38.7m, up from CN¥967.0k in one year. However, it does have CN¥75.0m in cash offsetting this, leading to net cash of CN¥36.3m.

A Look At Grace Wine Holdings' Liabilities

According to the last reported balance sheet, Grace Wine Holdings had liabilities of CN¥51.8m due within 12 months, and liabilities of CN¥22.8m due beyond 12 months. Offsetting this, it had CN¥75.0m in cash and CN¥10.7m in receivables that were due within 12 months. So it actually has CN¥11.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Grace Wine Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Grace Wine Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Grace Wine Holdings grew its EBIT by 61% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Grace Wine Holdings will need earnings to service that debt. 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. Grace Wine 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. Over the last three years, Grace Wine Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Grace Wine Holdings has net cash of CN¥36.3m, as well as more liquid assets than liabilities. And we liked the look of last year's 61% year-on-year EBIT growth. So we don't have any problem with Grace Wine Holdings's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Grace Wine Holdings , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.