Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Guangzhou Haige Communications Group Incorporated Company (SZSE:002465) makes use of debt. 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 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Guangzhou Haige Communications Group's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Guangzhou Haige Communications Group had debt of CN¥2.00b, up from CN¥606.0m in one year. But on the other hand it also has CN¥4.57b in cash, leading to a CN¥2.57b net cash position.
A Look At Guangzhou Haige Communications Group's Liabilities
We can see from the most recent balance sheet that Guangzhou Haige Communications Group had liabilities of CN¥5.16b falling due within a year, and liabilities of CN¥601.4m due beyond that. Offsetting these obligations, it had cash of CN¥4.57b as well as receivables valued at CN¥6.70b due within 12 months. So it can boast CN¥5.51b more liquid assets than total liabilities.
This excess liquidity suggests that Guangzhou Haige Communications Group is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Guangzhou Haige Communications Group has more cash than debt is arguably a good indication that it can manage its debt safely.
But the other side of the story is that Guangzhou Haige Communications Group saw its EBIT decline by 5.3% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Guangzhou Haige Communications Group'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Guangzhou Haige Communications 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. During the last three years, Guangzhou Haige Communications Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing Up
While it is always sensible to investigate a company's debt, in this case Guangzhou Haige Communications Group has CN¥2.57b in net cash and a decent-looking balance sheet. So we are not troubled with Guangzhou Haige Communications Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Guangzhou Haige Communications Group is showing 2 warning signs in our investment analysis , you should know about...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.