Li Lu, an external fund manager backed by Berkshire Hathaway’s Charlie Munger, says, “The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.” It has even been stated. So when you think about the risk of a particular stock, it might be obvious that you need to consider debt. Because too much debt can sink a company.I understand that Guangzhou Automobile Group Co., Ltd. (HKG:2238) uses debt in its operations. But is this debt a concern for shareholders?
When is debt a problem?
Debt supports a company until the company has difficulty paying it back with new capital or free cash flow. Part of capitalism is the process of “creative destruction” in which failing companies are ruthlessly liquidated by bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, resulting in permanent shareholder dilution. Of course, debt can be an important tool in business, especially in capital-heavy businesses. When we think about a company’s use of debt, we first think of cash and debt together.
Check out our latest analysis for Guangzhou Automobile Group.
What is Guangzhou Automobile Group’s net debt?
As shown below, at the end of September 2023, Guangzhou Automobile Group had debt of CA$25.3 billion, up from CA$21.3 billion a year ago. Click on the image for more information. However, it also has CA$50.5b in cash offsetting this, meaning it has CA$25.2b in net cash.
How strong is Guangzhou Automobile Group’s balance sheet?
The most recent balance sheet shows that Guangzhou Automobile Group had liabilities of RMB 68.8b falling due within a year, and liabilities of RMB 17.0b falling due beyond that. Offsetting these obligations, the company had cash of CA$50.5b and receivables worth CA$10.0b due within 12 months. So its total liabilities outweigh the sum of its cash and short-term receivables by CA$25.2b.
Guangzhou Automobile Group has a huge market capitalization of C$73.7 billion, so it is very likely that the company will raise cash to improve its balance sheet if necessary. However, it’s still worth carefully considering the company’s ability to repay its debt. Guangzhou Automobile Group does have notable debt, but it has more cash than debt, so we’re pretty confident that it can manage its debt safely. The balance sheet is clearly the area to focus on when analyzing debt. However, what will determine whether Guangzhou Automobile Group can maintain a healthy balance sheet in the future will be its future earnings above all else.If you’re focused on the future, check this out free A report showing analyst profit forecasts.
Guangzhou Automobile Group reported a 27% increase in revenue to C$128 billion for the 12-month period, but did not report profit before interest and tax. Shareholders are probably scratching their heads at the company’s potential for profitability.
So how dangerous is Guangzhou Automobile Group?
Guangzhou Automobile Group made an earnings before interest, tax and tax (EBIT) loss in the last 12 months, but its statutory profit was CA$4.5 billion. So if we take that at face value and factor in the cash, we don’t think it’s that risky in the short term. The good news for Guangzhou Automobile Group shareholders is that the company’s earnings growth is strong, making it easier to raise capital if needed. But that doesn’t change our opinion that this stock is risky. When analyzing debt levels, the balance sheet is the obvious place to start. Ultimately, however, any company can contain risks that exist outside the balance sheet.Case in point: we discovered Three warning signs for Guangzhou Automobile Group you should know.
If you’re more interested in fast-growing companies with rock-solid balance sheets, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodologies, and articles are not intended to be financial advice. This is not a recommendation to buy or sell any stock, and does not take into account your objectives or financial situation. We aim to provide long-term, focused analysis based on fundamental data. Note that our analysis may not factor in the latest announcements or qualitative material from price-sensitive companies. Simply Wall St has no position in any stocks mentioned.