Health Check: How Prudently Does Guangdong - Hong Kong Greater Bay Area Holdings (HKG:1396) Use Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Guangdong - Hong Kong Greater Bay Area Holdings Limited (HKG:1396) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Guangdong - Hong Kong Greater Bay Area Holdings

How Much Debt Does Guangdong - Hong Kong Greater Bay Area Holdings Carry?

As you can see below, at the end of December 2021, Guangdong - Hong Kong Greater Bay Area Holdings had CN¥7.59b of debt, up from CN¥4.07b a year ago. Click the image for more detail. On the flip side, it has CN¥3.00b in cash leading to net debt of about CN¥4.60b.

How Healthy Is Guangdong - Hong Kong Greater Bay Area Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangdong - Hong Kong Greater Bay Area Holdings had liabilities of CN¥12.6b due within 12 months and liabilities of CN¥5.73b due beyond that. Offsetting this, it had CN¥3.00b in cash and CN¥1.96b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥13.3b.

The deficiency here weighs heavily on the CN¥1.03b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Guangdong - Hong Kong Greater Bay Area Holdings 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 Guangdong - Hong Kong Greater Bay Area Holdings 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.

In the last year Guangdong - Hong Kong Greater Bay Area Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 49%, to CN¥5.6b. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though Guangdong - Hong Kong Greater Bay Area Holdings managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost CN¥59m at the EBIT level. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost CN¥498m in the last year. So we're not very excited about owning this stock. Its too risky for us. 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. To that end, you should learn about the 3 warning signs we've spotted with Guangdong - Hong Kong Greater Bay Area Holdings (including 2 which can't be ignored) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.