Does GDH Guangnan (Holdings) (HKG:1203) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that GDH Guangnan (Holdings) Limited (HKG:1203) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for GDH Guangnan (Holdings)

What Is GDH Guangnan (Holdings)'s Net Debt?

The image below, which you can click on for greater detail, shows that at June 2020 GDH Guangnan (Holdings) had debt of HK$54.7m, up from none in one year. But it also has HK$993.1m in cash to offset that, meaning it has HK$938.3m net cash.

How Healthy Is GDH Guangnan (Holdings)'s Balance Sheet?

According to the last reported balance sheet, GDH Guangnan (Holdings) had liabilities of HK$592.3m due within 12 months, and liabilities of HK$34.7m due beyond 12 months. On the other hand, it had cash of HK$993.1m and HK$630.5m worth of receivables due within a year. So it can boast HK$996.5m more liquid assets than total liabilities.

This surplus strongly suggests that GDH Guangnan (Holdings) has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, GDH Guangnan (Holdings) boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact GDH Guangnan (Holdings)'s saving grace is its low debt levels, because its EBIT has tanked 55% 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 GDH Guangnan (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. While GDH Guangnan (Holdings) 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, GDH Guangnan (Holdings) actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case GDH Guangnan (Holdings) has HK$938.3m in net cash and a strong balance sheet. The cherry on top was that in converted 215% of that EBIT to free cash flow, bringing in HK$163m. So we don't think GDH Guangnan (Holdings)'s use of debt is risky. 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. Take risks, for example - GDH Guangnan (Holdings) has 3 warning signs (and 1 which is a bit concerning) we think 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. 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.
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