Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Greentown Service Group Co. Ltd. (HKG:2869) makes use of debt. But should shareholders be worried about its use of debt?
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. 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, 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 Greentown Service Group Carry?
As you can see below, at the end of June 2019, Greentown Service Group had CN¥300.4m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.35b in cash, so it actually has CN¥2.05b net cash.
How Strong Is Greentown Service Group's Balance Sheet?
We can see from the most recent balance sheet that Greentown Service Group had liabilities of CN¥3.57b falling due within a year, and liabilities of CN¥780.2m due beyond that. Offsetting this, it had CN¥2.35b in cash and CN¥1.78b in receivables that were due within 12 months. So its liabilities total CN¥218.5m more than the combination of its cash and short-term receivables.
This state of affairs indicates that Greentown Service Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥18.2b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Greentown Service Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
While Greentown Service Group doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Greentown Service Group 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Greentown Service Group 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. Over the most recent three years, Greentown Service Group recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
We could understand if investors are concerned about Greentown Service Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥2.1b. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in CN¥324m. So is Greentown Service Group's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Greentown Service Group, you may well want to click here to check an interactive graph of its earnings per share history.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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