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Here's Why Geely Automobile Holdings (HKG:175) Can Manage Its Debt Responsibly

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. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Geely Automobile Holdings Limited (HKG:175) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Geely Automobile Holdings

What Is Geely Automobile Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Geely Automobile Holdings had CN¥3.42b in debt in June 2019; about the same as the year before. However, it does have CN¥14.0b in cash offsetting this, leading to net cash of CN¥10.6b.

SEHK:175 Historical Debt, March 18th 2020
SEHK:175 Historical Debt, March 18th 2020

How Healthy Is Geely Automobile Holdings's Balance Sheet?

According to the last reported balance sheet, Geely Automobile Holdings had liabilities of CN¥42.2b due within 12 months, and liabilities of CN¥2.35b due beyond 12 months. Offsetting these obligations, it had cash of CN¥14.0b as well as receivables valued at CN¥21.9b due within 12 months. So it has liabilities totalling CN¥8.67b more than its cash and near-term receivables, combined.

Given Geely Automobile Holdings has a humongous market capitalization of CN¥98.9b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Geely Automobile Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Geely Automobile Holdings's load is not too heavy, because its EBIT was down 25% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Geely Automobile Holdings'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Geely Automobile Holdings 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. In the last three years, Geely Automobile Holdings's free cash flow amounted to 50% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Geely Automobile Holdings has CN¥10.6b in net cash. So we are not troubled with Geely Automobile Holdings'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. Be aware that Geely Automobile Holdings is showing 2 warning signs in our investment analysis , you should know about...

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.

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.

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. Thank you for reading.

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