Is GreenTree Hospitality Group (NYSE:GHG) Using Too Much Debt?

Simply Wall St

Wed, Nov 24, 2021, 3:52 AM 4 min read

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that GreenTree Hospitality Group Ltd. (NYSE:GHG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for GreenTree Hospitality Group

What Is GreenTree Hospitality Group's Net Debt?

As you can see below, at the end of June 2021, GreenTree Hospitality Group had CN¥290.0m of debt, up from CN¥70.0m a year ago. Click the image for more detail. But it also has CN¥1.02b in cash to offset that, meaning it has CN¥727.4m net cash.

debt-equity-history-analysis — NYSE:GHG Debt to Equity History November 24th 2021

A Look At GreenTree Hospitality Group's Liabilities

The latest balance sheet data shows that GreenTree Hospitality Group had liabilities of CN¥1.06b due within a year, and liabilities of CN¥997.9m falling due after that. Offsetting this, it had CN¥1.02b in cash and CN¥445.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥594.7m more than its cash and near-term receivables, combined.

Since publicly traded GreenTree Hospitality Group shares are worth a total of CN¥5.27b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, GreenTree Hospitality Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that GreenTree Hospitality Group grew its EBIT at 10% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if GreenTree Hospitality Group 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. GreenTree Hospitality 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. Looking at the most recent three years, GreenTree Hospitality Group recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although GreenTree Hospitality Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥727.4m. On top of that, it increased its EBIT by 10% in the last twelve months. So we don't have any problem with GreenTree Hospitality Group'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 2 warning signs for GreenTree Hospitality Group (1 is a bit concerning!) 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.

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.

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