Daohe Global Group (HKG:915) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Daohe Global Group Limited (HKG:915) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Daohe Global Group

What Is Daohe Global Group's Net Debt?

The image below, which you can click on for greater detail, shows that Daohe Global Group had debt of US$4.27m at the end of December 2022, a reduction from US$5.02m over a year. But it also has US$18.4m in cash to offset that, meaning it has US$14.1m net cash.

How Healthy Is Daohe Global Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Daohe Global Group had liabilities of US$14.1m due within 12 months and liabilities of US$877.0k due beyond that. Offsetting this, it had US$18.4m in cash and US$5.04m in receivables that were due within 12 months. So it can boast US$8.43m more liquid assets than total liabilities.

This excess liquidity is a great indication that Daohe Global Group's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Daohe Global Group has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Daohe Global Group's load is not too heavy, because its EBIT was down 86% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Daohe Global Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Daohe Global 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. Happily for any shareholders, Daohe Global Group actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Daohe Global Group has net cash of US$14.1m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$4.6m, being 235% of its EBIT. So is Daohe Global Group'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. Be aware that Daohe Global Group is showing 4 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.