These 4 Measures Indicate That Everbright Grand China Assets (HKG:3699) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Everbright Grand China Assets Limited (HKG:3699) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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.

See our latest analysis for Everbright Grand China Assets

What Is Everbright Grand China Assets's Net Debt?

The image below, which you can click on for greater detail, shows that Everbright Grand China Assets had debt of CN¥17.3m at the end of June 2020, a reduction from CN¥23.5m over a year. But on the other hand it also has CN¥204.0m in cash, leading to a CN¥186.8m net cash position.

How Healthy Is Everbright Grand China Assets's Balance Sheet?

According to the last reported balance sheet, Everbright Grand China Assets had liabilities of CN¥37.9m due within 12 months, and liabilities of CN¥196.6m due beyond 12 months. Offsetting this, it had CN¥204.0m in cash and CN¥12.1m in receivables that were due within 12 months. So its liabilities total CN¥18.4m more than the combination of its cash and short-term receivables.

Of course, Everbright Grand China Assets has a market capitalization of CN¥186.0m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Everbright Grand China Assets boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Everbright Grand China Assets if management cannot prevent a repeat of the 23% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Everbright Grand China Assets will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Everbright Grand China Assets 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. Happily for any shareholders, Everbright Grand China Assets actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

We could understand if investors are concerned about Everbright Grand China Assets's liabilities, but we can be reassured by the fact it has has net cash of CN¥186.8m. And it impressed us with free cash flow of CN¥22m, being 112% of its EBIT. So we are not troubled with Everbright Grand China Assets's debt use. 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. Take risks, for example - Everbright Grand China Assets has 3 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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