Greentown Service Group (HKG:2869) Seems To Use Debt Quite Sensibly

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. We can see that Greentown Service Group Co. Ltd. (HKG:2869) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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 Greentown Service Group

What Is Greentown Service Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Greentown Service Group had CN¥281.6m of debt, an increase on CN¥189.8m, over one year. However, its balance sheet shows it holds CN¥5.20b in cash, so it actually has CN¥4.92b net cash.

How Strong Is Greentown Service Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Greentown Service Group had liabilities of CN¥8.32b due within 12 months and liabilities of CN¥1.32b due beyond that. Offsetting these obligations, it had cash of CN¥5.20b as well as receivables valued at CN¥5.51b due within 12 months. So it actually has CN¥1.06b more liquid assets than total liabilities.

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

On the other hand, Greentown Service Group saw its EBIT drop by 3.2% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Greentown Service Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Greentown Service 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 most recent three years, Greentown Service Group recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Greentown Service Group has net cash of CN¥4.92b, as well as more liquid assets than liabilities. So we don't think Greentown Service Group's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Greentown Service Group, you may well want to click here to check an interactive graph of its earnings per share history.

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.