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.' 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. We note that Country Garden Services Holdings Company Limited (HKG:6098) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Country Garden Services Holdings's Net Debt?
As you can see below, at the end of June 2021, Country Garden Services Holdings had CN¥4.73b of debt, up from CN¥3.39b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥25.1b in cash, so it actually has CN¥20.3b net cash.
How Strong Is Country Garden Services Holdings' Balance Sheet?
According to the last reported balance sheet, Country Garden Services Holdings had liabilities of CN¥18.7b due within 12 months, and liabilities of CN¥2.38b due beyond 12 months. Offsetting these obligations, it had cash of CN¥25.1b as well as receivables valued at CN¥8.00b due within 12 months. So it actually has CN¥12.0b more liquid assets than total liabilities.
This short term liquidity is a sign that Country Garden Services Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Country Garden Services Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Country Garden Services Holdings grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Country Garden Services Holdings'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Country Garden Services Holdings 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. Over the last three years, Country Garden Services Holdings recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Country Garden Services Holdings has net cash of CN¥20.3b, as well as more liquid assets than liabilities. The cherry on top was that in converted 95% of that EBIT to free cash flow, bringing in CN¥3.1b. So is Country Garden Services Holdings'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. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Country Garden Services Holdings that you should be aware of before investing here.
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.