Warren Buffett famously said, '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. Importantly, Guoan International Limited (HKG:143) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Guoan International
What Is Guoan International's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Guoan International had HK$460.0m of debt, an increase on HK$8.10m, over one year. However, because it has a cash reserve of HK$128.5m, its net debt is less, at about HK$331.5m.
How Strong Is Guoan International's Balance Sheet?
According to the last reported balance sheet, Guoan International had liabilities of HK$486.2m due within 12 months, and liabilities of HK$189.5m due beyond 12 months. On the other hand, it had cash of HK$128.5m and HK$205.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$341.6m.
While this might seem like a lot, it is not so bad since Guoan International has a market capitalization of HK$643.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Guoan International will need earnings to service that debt. 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.
Over 12 months, Guoan International reported revenue of HK$155m, which is a gain of 53%. With any luck the company will be able to grow its way to profitability.
Caveat Emptor
While we can certainly savour Guoan International's tasty revenue growth, its negative earnings before interest and tax (EBIT) leaves a bitter aftertaste. To be specific the EBIT loss came in at HK$39m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through HK$83m of cash over the last year. So in short it's a really risky stock. For riskier companies like Guoan International I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.