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.' 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 Golden Eagle Retail Group Limited (HKG:3308) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Golden Eagle Retail Group's Net Debt?
As you can see below, Golden Eagle Retail Group had CN¥6.25b of debt at December 2020, down from CN¥6.73b a year prior. But on the other hand it also has CN¥6.78b in cash, leading to a CN¥531.2m net cash position.
How Healthy Is Golden Eagle Retail Group's Balance Sheet?
According to the last reported balance sheet, Golden Eagle Retail Group had liabilities of CN¥12.3b due within 12 months, and liabilities of CN¥4.00b due beyond 12 months. On the other hand, it had cash of CN¥6.78b and CN¥555.8m worth of receivables due within a year. So its liabilities total CN¥8.96b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of CN¥9.77b, so it does suggest shareholders should keep an eye on Golden Eagle Retail Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Golden Eagle Retail Group boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Golden Eagle Retail Group saw its EBIT drop by 5.8% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Golden Eagle Retail Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Golden Eagle Retail Group 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. Looking at the most recent three years, Golden Eagle Retail Group recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While Golden Eagle Retail Group does have more liabilities than liquid assets, it also has net cash of CN¥531.2m. So although we see some areas for improvement, we're not too worried about Golden Eagle Retail Group's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Golden Eagle Retail Group (of which 1 is significant!) you should know about.
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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