Does Grand Baoxin Auto Group (HKG:1293) Have A Healthy Balance Sheet?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Grand Baoxin Auto Group Limited (HKG:1293) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for Grand Baoxin Auto Group

What Is Grand Baoxin Auto Group's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Grand Baoxin Auto Group had debt of CN¥8.09b, up from CN¥6.39b in one year. However, because it has a cash reserve of CN¥1.07b, its net debt is less, at about CN¥7.02b.

How Strong Is Grand Baoxin Auto Group's Balance Sheet?

We can see from the most recent balance sheet that Grand Baoxin Auto Group had liabilities of CN¥11.8b falling due within a year, and liabilities of CN¥4.30b due beyond that. Offsetting these obligations, it had cash of CN¥1.07b as well as receivables valued at CN¥719.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥14.3b.

This deficit casts a shadow over the CN¥1.20b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Grand Baoxin Auto Group would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Grand Baoxin Auto Group has a debt to EBITDA ratio of 3.7 and its EBIT covered its interest expense 2.9 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Grand Baoxin Auto Group improved its EBIT by 3.5% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Grand Baoxin Auto 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Grand Baoxin Auto Group produced sturdy free cash flow equating to 76% 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.

Our View

We'd go so far as to say Grand Baoxin Auto Group's level of total liabilities was disappointing. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Grand Baoxin Auto Group's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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 instance, we've identified 1 warning sign for Grand Baoxin Auto Group that you should be aware of.

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.