Guangdong Investment (HKG:270) Has A Pretty Healthy Balance Sheet

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.' 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 Guangdong Investment Limited (HKG:270) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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When Is Debt A Problem?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Guangdong Investment Carry?

As you can see below, Guangdong Investment had HK$24.3b of debt at December 2024, down from HK$42.9b a year prior. However, it also had HK$12.2b in cash, and so its net debt is HK$12.1b.

How Strong Is Guangdong Investment's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Investment had liabilities of HK$55.7b falling due within a year, and liabilities of HK$23.2b due beyond that. Offsetting this, it had HK$12.2b in cash and HK$7.51b in receivables that were due within 12 months. So its liabilities total HK$59.3b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$37.7b 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, Guangdong Investment would probably need a major re-capitalization if its creditors were to demand repayment.

Check out our latest analysis for Guangdong Investment

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Guangdong Investment's net debt is only 1.3 times its EBITDA. And its EBIT covers its interest expense a whopping 11.7 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, Guangdong Investment grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. 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 Guangdong Investment 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 always check how much of that EBIT is translated into free cash flow. During the last three years, Guangdong Investment generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Both Guangdong Investment's ability to to convert EBIT to free cash flow and its interest cover gave us comfort that it can handle its debt. But truth be told its level of total liabilities had us nibbling our nails. It's also worth noting that Guangdong Investment is in the Water Utilities industry, which is often considered to be quite defensive. When we consider all the elements mentioned above, it seems to us that Guangdong Investment is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. To that end, you should learn about the 2 warning signs we've spotted with Guangdong Investment (including 1 which 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.