Is Greenheart Group (HKG:94) Using Debt In A Risky Way?

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 Greenheart Group Limited (HKG:94) 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Greenheart Group

How Much Debt Does Greenheart Group Carry?

The chart below, which you can click on for greater detail, shows that Greenheart Group had HK$402.1m in debt in December 2020; about the same as the year before. However, it also had HK$167.7m in cash, and so its net debt is HK$234.4m.

A Look At Greenheart Group's Liabilities

According to the last reported balance sheet, Greenheart Group had liabilities of HK$114.4m due within 12 months, and liabilities of HK$519.2m due beyond 12 months. Offsetting this, it had HK$167.7m in cash and HK$28.9m in receivables that were due within 12 months. So it has liabilities totalling HK$437.0m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$224.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Greenheart Group 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 you can't view debt in total isolation; since Greenheart Group 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.

Over 12 months, Greenheart Group made a loss at the EBIT level, and saw its revenue drop to HK$326m, which is a fall of 13%. We would much prefer see growth.

Caveat Emptor

While Greenheart Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping HK$86m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of HK$17m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Greenheart Group you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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