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. We note that Giordano International Limited (HKG:709) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Giordano International's Debt?
As you can see below, Giordano International had HK$298.0m of debt, at December 2018, which is about the same the year before. You can click the chart for greater detail. However, its balance sheet shows it holds HK$1.32b in cash, so it actually has HK$1.02b net cash.
A Look At Giordano International's Liabilities
Zooming in on the latest balance sheet data, we can see that Giordano International had liabilities of HK$992.0m due within 12 months and liabilities of HK$123.0m due beyond that. Offsetting this, it had HK$1.32b in cash and HK$528.0m in receivables that were due within 12 months. So it actually has HK$728.0m more liquid assets than total liabilities.
This excess liquidity suggests that Giordano International is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Giordano International boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Giordano International saw its EBIT drop by 7.1% in the last twelve months. 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 Giordano International'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. While Giordano International 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. During the last three years, Giordano International generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case Giordano International has HK$1.0b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$455m, being 84% of its EBIT. So we don't think Giordano International's use of debt is risky. Another factor that would give us confidence in Giordano International would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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