Here's Why Guangdong Kanghua Healthcare Group (HKG:3689) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Guangdong Kanghua Healthcare Group Co., Ltd. (HKG:3689) does carry debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Guangdong Kanghua Healthcare Group

What Is Guangdong Kanghua Healthcare Group's Debt?

As you can see below, Guangdong Kanghua Healthcare Group had CN¥246.6m of debt at June 2024, down from CN¥296.7m a year prior. However, its balance sheet shows it holds CN¥536.0m in cash, so it actually has CN¥289.4m net cash.

How Strong Is Guangdong Kanghua Healthcare Group's Balance Sheet?

The latest balance sheet data shows that Guangdong Kanghua Healthcare Group had liabilities of CN¥772.7m due within a year, and liabilities of CN¥452.8m falling due after that. Offsetting this, it had CN¥536.0m in cash and CN¥344.4m in receivables that were due within 12 months. So it has liabilities totalling CN¥345.1m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥560.4m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Guangdong Kanghua Healthcare Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Guangdong Kanghua Healthcare Group's saving grace is its low debt levels, because its EBIT has tanked 23% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Guangdong Kanghua Healthcare Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Guangdong Kanghua Healthcare Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Guangdong Kanghua Healthcare Group 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 Guangdong Kanghua Healthcare Group'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¥289.4m. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in CN¥93m. So we are not troubled with Guangdong Kanghua Healthcare Group's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Guangdong Kanghua Healthcare Group that you should be aware of.

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.