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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Jiangxi Guoguang Commercial Chains Co., Ltd. (SHSE:605188) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Jiangxi Guoguang Commercial Chains
What Is Jiangxi Guoguang Commercial Chains's Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Jiangxi Guoguang Commercial Chains had debt of CN¥100.9m, up from none in one year. But it also has CN¥771.6m in cash to offset that, meaning it has CN¥670.7m net cash.
How Strong Is Jiangxi Guoguang Commercial Chains' Balance Sheet?
According to the last reported balance sheet, Jiangxi Guoguang Commercial Chains had liabilities of CN¥1.02b due within 12 months, and liabilities of CN¥669.9m due beyond 12 months. On the other hand, it had cash of CN¥771.6m and CN¥85.0m worth of receivables due within a year. So its liabilities total CN¥833.4m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Jiangxi Guoguang Commercial Chains has a market capitalization of CN¥3.85b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Jiangxi Guoguang Commercial Chains boasts net cash, so it's fair to say it does not have a heavy debt load!
Notably Jiangxi Guoguang Commercial Chains's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jiangxi Guoguang Commercial Chains's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Jiangxi Guoguang Commercial Chains 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. Happily for any shareholders, Jiangxi Guoguang Commercial Chains actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
While Jiangxi Guoguang Commercial Chains does have more liabilities than liquid assets, it also has net cash of CN¥670.7m. And it impressed us with free cash flow of CN¥124m, being 354% of its EBIT. So we don't have any problem with Jiangxi Guoguang Commercial Chains's use of debt. 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, we've discovered 3 warning signs for Jiangxi Guoguang Commercial Chains (2 can't be ignored!) that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.