Greentown Service Group (HKG:2869) Seems To Use Debt Rather Sparingly

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 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. Importantly, Greentown Service Group Co. Ltd. (HKG:2869) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Greentown Service Group

How Much Debt Does Greentown Service Group Carry?

As you can see below, Greentown Service Group had CN¥173.3m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥5.93b in cash, so it actually has CN¥5.75b net cash.

A Look At Greentown Service Group's Liabilities

The latest balance sheet data shows that Greentown Service Group had liabilities of CN¥5.79b due within a year, and liabilities of CN¥1.22b falling due after that. Offsetting these obligations, it had cash of CN¥5.93b as well as receivables valued at CN¥2.63b due within 12 months. So it can boast CN¥1.56b 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. Simply put, the fact that Greentown Service Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Greentown Service Group grew its EBIT at 18% over the last year, further increasing its ability to manage debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Greentown Service Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Greentown Service Group generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Greentown Service Group has CN¥5.75b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in CN¥609m. So is Greentown Service Group's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Greentown Service Group has 1 warning sign we think you should be aware of.

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.