Here's Why Great Harvest Maeta Holdings (HKG:3683) Has A Meaningful Debt Burden

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.' 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. Importantly, Great Harvest Maeta Holdings Limited (HKG:3683) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Great Harvest Maeta Holdings

What Is Great Harvest Maeta Holdings's Net Debt?

As you can see below, Great Harvest Maeta Holdings had US$79.1m of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had US$4.36m in cash, and so its net debt is US$74.7m.

How Healthy Is Great Harvest Maeta Holdings' Balance Sheet?

The latest balance sheet data shows that Great Harvest Maeta Holdings had liabilities of US$77.9m due within a year, and liabilities of US$27.3m falling due after that. Offsetting these obligations, it had cash of US$4.36m as well as receivables valued at US$1.25m due within 12 months. So its liabilities total US$99.6m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$16.0m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Great Harvest Maeta Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.89 times and a disturbingly high net debt to EBITDA ratio of 9.7 hit our confidence in Great Harvest Maeta Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that Great Harvest Maeta Holdings achieved a positive EBIT of US$4.1m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Great Harvest Maeta Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Great Harvest Maeta Holdings actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, Great Harvest Maeta Holdings's interest cover 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. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We're quite clear that we consider Great Harvest Maeta Holdings to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Great Harvest Maeta Holdings (of which 1 doesn't sit too well with us!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.