Grand Baoxin Auto Group (HKG:1293) Has No Shortage Of 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. We can see that Grand Baoxin Auto Group Limited (HKG:1293) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Grand Baoxin Auto Group

What Is Grand Baoxin Auto Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Grand Baoxin Auto Group had CN¥6.05b of debt in December 2020, down from CN¥9.66b, one year before. On the flip side, it has CN¥1.97b in cash leading to net debt of about CN¥4.08b.

A Look At Grand Baoxin Auto Group's Liabilities

We can see from the most recent balance sheet that Grand Baoxin Auto Group had liabilities of CN¥14.5b falling due within a year, and liabilities of CN¥6.05b due beyond that. Offsetting this, it had CN¥1.97b in cash and CN¥656.9m in receivables that were due within 12 months. So it has liabilities totalling CN¥17.9b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥2.10b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Grand Baoxin Auto Group would probably need a major re-capitalization if its creditors were to demand repayment.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Grand Baoxin Auto Group's debt to EBITDA ratio (2.9) suggests that it uses some debt, its interest cover is very weak, at 1.6, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even worse, Grand Baoxin Auto Group saw its EBIT tank 41% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Grand Baoxin Auto 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Grand Baoxin Auto Group recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Grand Baoxin Auto Group's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its conversion of EBIT to free cash flow fails to inspire much confidence. After considering the datapoints discussed, we think Grand Baoxin Auto Group has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Grand Baoxin Auto Group (1 is a bit concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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