We Think Greentown Service Group (HKG:2869) Can Stay On Top Of Its 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.' 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. As with many other companies Greentown Service Group Co. Ltd. (HKG:2869) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

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How Much Debt Does Greentown Service Group Carry?

As you can see below, at the end of June 2022, Greentown Service Group had CN¥189.8m of debt, up from CN¥171.9m a year ago. Click the image for more detail. But it also has CN¥5.56b in cash to offset that, meaning it has CN¥5.37b net cash.

A Look At Greentown Service Group's Liabilities

We can see from the most recent balance sheet that Greentown Service Group had liabilities of CN¥6.96b falling due within a year, and liabilities of CN¥1.29b due beyond that. Offsetting this, it had CN¥5.56b in cash and CN¥4.24b in receivables that were due within 12 months. So it can boast CN¥1.54b more liquid assets than total liabilities.

This short term liquidity is a sign that Greentown Service Group could probably pay off its debt with ease, as its balance sheet is far from stretched. 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.

On the other hand, Greentown Service Group saw its EBIT drop by 5.0% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Greentown Service Group can strengthen its balance sheet over time. 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. 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 produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Greentown Service Group has CN¥5.37b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in CN¥100m. So we don't think Greentown Service Group's use of debt is risky. 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 3 warning signs (and 1 which shouldn't be ignored) we think 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.