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 GrandiT Co., Ltd. (SHSE:688549) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is GrandiT's Debt?
The image below, which you can click on for greater detail, shows that GrandiT had debt of CN¥129.0m at the end of December 2023, a reduction from CN¥276.9m over a year. However, its balance sheet shows it holds CN¥1.73b in cash, so it actually has CN¥1.61b net cash.
How Healthy Is GrandiT's Balance Sheet?
The latest balance sheet data shows that GrandiT had liabilities of CN¥682.6m due within a year, and liabilities of CN¥166.7m falling due after that. Offsetting these obligations, it had cash of CN¥1.73b as well as receivables valued at CN¥280.7m due within 12 months. So it actually has CN¥1.17b more liquid assets than total liabilities.
This short term liquidity is a sign that GrandiT could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, GrandiT boasts net cash, so it's fair to say it does not have a heavy debt load!
Although GrandiT made a loss at the EBIT level, last year, it was also good to see that it generated CN¥53m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is GrandiT'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While GrandiT 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. Over the last year, GrandiT saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that GrandiT has net cash of CN¥1.61b, as well as more liquid assets than liabilities. So we don't have any problem with GrandiT's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for GrandiT that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.