Is Grace Wine Holdings (HKG:8146) Using Too Much Debt?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Grace Wine Holdings Limited (HKG:8146) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Grace Wine Holdings

What Is Grace Wine Holdings's Debt?

As you can see below, at the end of June 2023, Grace Wine Holdings had CN¥27.3m of debt, up from CN¥25.3m a year ago. Click the image for more detail. But it also has CN¥57.6m in cash to offset that, meaning it has CN¥30.3m net cash.

How Healthy Is Grace Wine Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Grace Wine Holdings had liabilities of CN¥29.4m due within 12 months and liabilities of CN¥22.7m due beyond that. Offsetting this, it had CN¥57.6m in cash and CN¥1.26m in receivables that were due within 12 months. So it actually has CN¥6.76m more liquid assets than total liabilities.

This surplus suggests that Grace Wine Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Grace Wine Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Grace Wine Holdings grew its EBIT at 16% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Grace Wine 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. During the last three years, Grace Wine Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Grace Wine Holdings has CN¥30.3m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 16% over the last year. So we are not troubled with Grace Wine Holdings's debt use. There's no doubt that we learn most about debt from the balance sheet. 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 1 warning sign for Grace Wine Holdings you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.