Is GreenTree Hospitality Group (NYSE:GHG) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 GreenTree Hospitality Group Ltd. (NYSE:GHG) makes use of debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for GreenTree Hospitality Group

How Much Debt Does GreenTree Hospitality Group Carry?

As you can see below, GreenTree Hospitality Group had CN¥60.0m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥954.6m in cash to offset that, meaning it has CN¥894.6m net cash.

How Strong Is GreenTree Hospitality Group's Balance Sheet?

We can see from the most recent balance sheet that GreenTree Hospitality Group had liabilities of CN¥783.9m falling due within a year, and liabilities of CN¥1.02b due beyond that. Offsetting these obligations, it had cash of CN¥954.6m as well as receivables valued at CN¥331.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥513.4m.

Given GreenTree Hospitality Group has a market capitalization of CN¥8.59b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, GreenTree Hospitality Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for GreenTree Hospitality Group if management cannot prevent a repeat of the 44% cut to EBIT 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 it is future earnings, more than anything, that will determine GreenTree Hospitality Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While GreenTree Hospitality 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. During the last three years, GreenTree Hospitality Group produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

We could understand if investors are concerned about GreenTree Hospitality Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥894.6m. And it impressed us with free cash flow of CN¥58m, being 72% of its EBIT. So we are not troubled with GreenTree Hospitality Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for GreenTree Hospitality Group that you should be aware of.

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.

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