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. Importantly, Greatview Aseptic Packaging Company Limited (HKG:468) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Greatview Aseptic Packaging's Debt?
As you can see below, Greatview Aseptic Packaging had CN¥128.1m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. But on the other hand it also has CN¥455.9m in cash, leading to a CN¥327.8m net cash position.
How Healthy Is Greatview Aseptic Packaging's Balance Sheet?
According to the last reported balance sheet, Greatview Aseptic Packaging had liabilities of CN¥668.8m due within 12 months, and liabilities of CN¥117.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥455.9m as well as receivables valued at CN¥468.5m due within 12 months. So it actually has CN¥138.2m more liquid assets than total liabilities.
This surplus suggests that Greatview Aseptic Packaging has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Greatview Aseptic Packaging boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Greatview Aseptic Packaging saw its EBIT decline by 8.7% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Greatview Aseptic Packaging can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Greatview Aseptic Packaging 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. In the last three years, Greatview Aseptic Packaging's free cash flow amounted to 43% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to investigate a company's debt, in this case Greatview Aseptic Packaging has CN¥327.8m in net cash and a decent-looking balance sheet. So we are not troubled with Greatview Aseptic Packaging's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Greatview Aseptic Packaging .
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.
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.
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