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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that GreenTree Hospitality Group Ltd. (NYSE:GHG) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is GreenTree Hospitality Group's Debt?
As you can see below, at the end of March 2019, GreenTree Hospitality Group had CN¥60.0m of debt, up from none a year ago. Click the image for more detail. However, it does have CN¥1.48b in cash offsetting this, leading to net cash of CN¥1.42b.
How Strong Is GreenTree Hospitality Group's Balance Sheet?
We can see from the most recent balance sheet that GreenTree Hospitality Group had liabilities of CN¥739.0m falling due within a year, and liabilities of CN¥725.0m due beyond that. Offsetting these obligations, it had cash of CN¥1.48b as well as receivables valued at CN¥190.4m due within 12 months. So it can boast CN¥202.0m more liquid assets than total liabilities.
This surplus suggests that GreenTree Hospitality Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that GreenTree Hospitality Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that GreenTree Hospitality Group grew its EBIT at 17% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine GreenTree Hospitality 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. While GreenTree Hospitality Group 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, GreenTree Hospitality Group generated free cash flow amounting to a very robust 100% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that GreenTree Hospitality Group has net cash of CN¥1.4b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥468m, being 100% of its EBIT. So is GreenTree Hospitality 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 GreenTree Hospitality Group, you may well want to click here to check an interactive graph of its earnings per share history.
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 firstname.lastname@example.org. 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.