These 4 Measures Indicate That Aoyuan Healthy Life Group (HKG:3662) Is Using Debt Reasonably Well

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Aoyuan Healthy Life Group Company Limited (HKG:3662) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Aoyuan Healthy Life Group

What Is Aoyuan Healthy Life Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Aoyuan Healthy Life Group had CN¥135.0m of debt in June 2023, down from CN¥210.0m, one year before. However, it does have CN¥869.7m in cash offsetting this, leading to net cash of CN¥734.7m.

How Healthy Is Aoyuan Healthy Life Group's Balance Sheet?

The latest balance sheet data shows that Aoyuan Healthy Life Group had liabilities of CN¥1.04b due within a year, and liabilities of CN¥24.3m falling due after that. Offsetting this, it had CN¥869.7m in cash and CN¥675.6m in receivables that were due within 12 months. So it can boast CN¥481.2m more liquid assets than total liabilities.

This surplus liquidity suggests that Aoyuan Healthy Life Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Aoyuan Healthy Life Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Aoyuan Healthy Life Group made a loss at the EBIT level, last year, it was also good to see that it generated CN¥152m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Aoyuan Healthy Life Group will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Aoyuan Healthy Life 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. In the last year, Aoyuan Healthy Life Group basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Aoyuan Healthy Life Group has CN¥734.7m in net cash and a strong balance sheet. So we don't think Aoyuan Healthy Life Group'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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Aoyuan Healthy Life Group (of which 2 are a bit unpleasant!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.