GDS Holdings (NASDAQ:GDS) Seems To Use Debt Quite Sensibly

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. We can see that GDS Holdings Limited (NASDAQ:GDS) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for GDS Holdings

What Is GDS Holdings's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 GDS Holdings had debt of CN¥14.6b, up from CN¥11.3b in one year. However, it does have CN¥16.3b in cash offsetting this, leading to net cash of CN¥1.61b.

How Strong Is GDS Holdings' Balance Sheet?

According to the last reported balance sheet, GDS Holdings had liabilities of CN¥7.64b due within 12 months, and liabilities of CN¥22.9b due beyond 12 months. Offsetting this, it had CN¥16.3b in cash and CN¥1.64b in receivables that were due within 12 months. So it has liabilities totalling CN¥12.7b more than its cash and near-term receivables, combined.

Since publicly traded GDS Holdings shares are worth a very impressive total of CN¥99.5b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, GDS Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is well worth noting that GDS Holdings's EBIT shot up like bamboo after rain, gaining 40% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if GDS Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. GDS Holdings 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. During the last three years, GDS Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

Although GDS Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥1.61b. And it impressed us with its EBIT growth of 40% over the last year. So we are not troubled with GDS Holdings's debt use. 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. For example - GDS Holdings has 2 warning signs we think you should be aware of.

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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