Is Country Garden Services Holdings (HKG:6098) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that 6098 is potentially undervalued!

How Much Debt Does Country Garden Services Holdings Carry?

The image below, which you can click on for greater detail, shows that Country Garden Services Holdings had debt of CN¥1.86b at the end of June 2022, a reduction from CN¥4.73b over a year. However, it does have CN¥13.1b in cash offsetting this, leading to net cash of CN¥11.3b.

How Strong Is Country Garden Services Holdings' Balance Sheet?

According to the last reported balance sheet, Country Garden Services Holdings had liabilities of CN¥23.8b due within 12 months, and liabilities of CN¥3.92b due beyond 12 months. Offsetting these obligations, it had cash of CN¥13.1b as well as receivables valued at CN¥16.3b due within 12 months. So it can boast CN¥1.77b more liquid assets than total liabilities.

This surplus suggests that Country Garden Services Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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.

In addition to that, we're happy to report that Country Garden Services Holdings has boosted its EBIT by 44%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Country Garden Services Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Country Garden Services Holdings 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. Over the last three years, Country Garden Services Holdings recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Country Garden Services Holdings has CN¥11.3b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in CN¥4.3b. So we don't think Country Garden Services Holdings'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. Be aware that Country Garden Services Holdings is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.