These 4 Measures Indicate That Grand Baoxin Auto Group (HKG:1293) Is Using Debt Extensively
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Grand Baoxin Auto Group Limited (HKG:1293) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Grand Baoxin Auto Group
What Is Grand Baoxin Auto Group's Debt?
As you can see below, at the end of December 2018, Grand Baoxin Auto Group had CN¥9.91b of debt, up from CN¥8.97b a year ago. Click the image for more detail. On the flip side, it has CN¥2.61b in cash leading to net debt of about CN¥7.30b.
How Strong Is Grand Baoxin Auto Group's Balance Sheet?
We can see from the most recent balance sheet that Grand Baoxin Auto Group had liabilities of CN¥14.2b falling due within a year, and liabilities of CN¥6.88b due beyond that. Offsetting this, it had CN¥2.61b in cash and CN¥7.65b in receivables that were due within 12 months. So it has liabilities totalling CN¥10.8b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the CN¥4.10b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, Grand Baoxin Auto Group 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Grand Baoxin Auto Group has a debt to EBITDA ratio of 3.5 and its EBIT covered its interest expense 2.5 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Grand Baoxin Auto Group's EBIT was pretty flat over the last year, which isn't ideal given the debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Grand Baoxin Auto Group's ability to maintain a healthy balance sheet going forward. 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. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Grand Baoxin Auto Group recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Our View
Mulling over Grand Baoxin Auto Group's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that Grand Baoxin Auto Group's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. Given the risks around Grand Baoxin Auto Group's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
