Is Daohe Global Group (HKG:915) A Risky Investment?

Warren Buffett famously said, '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 can see that Daohe Global Group Limited (HKG:915) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out the opportunities and risks within the HK Retail Distributors industry.

What Is Daohe Global Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Daohe Global Group had US$4.78m of debt, an increase on US$3.86m, over one year. But on the other hand it also has US$15.6m in cash, leading to a US$10.8m net cash position.

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$17.1m due within 12 months and liabilities of US$1.24m due beyond that. Offsetting these obligations, it had cash of US$15.6m as well as receivables valued at US$6.23m due within 12 months. So it actually has US$3.54m more liquid assets than total liabilities.

It's good to see that Daohe Global Group has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. 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.

Even more impressive was the fact that Daohe Global Group grew its EBIT by 125% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Daohe Global Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Daohe Global Group 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. Happily for any shareholders, Daohe Global Group actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

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$10.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 129% of that EBIT to free cash flow, bringing in US$4.0m. When it comes to Daohe Global Group's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Daohe Global Group you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.