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.' 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. Importantly, Greatview Aseptic Packaging Company Limited (HKG:468) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.
What Is Greatview Aseptic Packaging's Net Debt?
As you can see below, at the end of December 2018, Greatview Aseptic Packaging had CN¥190.4m of debt, up from CN¥112.9m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥556.4m in cash, so it actually has CN¥366.0m net cash.
How Healthy Is Greatview Aseptic Packaging's Balance Sheet?
We can see from the most recent balance sheet that Greatview Aseptic Packaging had liabilities of CN¥661.6m falling due within a year, and liabilities of CN¥119.5m due beyond that. On the other hand, it had cash of CN¥556.4m and CN¥430.6m worth of receivables due within a year. So it can boast CN¥205.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Greatview Aseptic Packaging could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Greatview Aseptic Packaging boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Greatview Aseptic Packaging saw its EBIT decline by 4.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its 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 Greatview Aseptic Packaging'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 Greatview Aseptic Packaging 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. Over the most recent three years, Greatview Aseptic Packaging recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While we empathize with investors who find debt concerning, you should keep in mind that Greatview Aseptic Packaging has net cash of CN¥366m, as well as more liquid assets than liabilities. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in CN¥276m. So is Greatview Aseptic Packaging's debt a risk? It doesn't seem so to us. Given Greatview Aseptic Packaging has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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