Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Guangdong Advertising Group Co.,Ltd (SZSE:002400) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. If things get really bad, the lenders can take control of the business. 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. 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.
What Is Guangdong Advertising GroupLtd's Net Debt?
As you can see below, at the end of December 2023, Guangdong Advertising GroupLtd had CN¥837.5m of debt, up from CN¥519.5m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.09b in cash, so it actually has CN¥1.25b net cash.
How Strong Is Guangdong Advertising GroupLtd's Balance Sheet?
We can see from the most recent balance sheet that Guangdong Advertising GroupLtd had liabilities of CN¥5.39b falling due within a year, and liabilities of CN¥258.8m due beyond that. Offsetting these obligations, it had cash of CN¥2.09b as well as receivables valued at CN¥4.58b due within 12 months. So it actually has CN¥1.02b more liquid assets than total liabilities.
This surplus suggests that Guangdong Advertising GroupLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Guangdong Advertising GroupLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Guangdong Advertising GroupLtd if management cannot prevent a repeat of the 49% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is Guangdong Advertising GroupLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Guangdong Advertising GroupLtd 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 last three years, Guangdong Advertising GroupLtd recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Guangdong Advertising GroupLtd has net cash of CN¥1.25b, as well as more liquid assets than liabilities. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in CN¥438m. So we are not troubled with Guangdong Advertising GroupLtd's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Guangdong Advertising GroupLtd has 1 warning sign we think you should be aware of.
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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
