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. Importantly, Golden Eagle Retail Group Limited (HKG:3308) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 examine debt levels, we first consider both cash and debt levels, together.
Check out the opportunities and risks within the HK Multiline Retail industry.
What Is Golden Eagle Retail Group’s Debt?
The image below, which you can click on for greater detail, shows that at June 2022 Golden Eagle Retail Group had debt of CN¥6.54b, up from CN¥6.28b in one year. However, it does have CN¥7.90b in cash offsetting this, leading to net cash of CN¥1.36b.
A Look At Golden Eagle Retail Group’s Liabilities
Zooming in on the latest balance sheet data, we can see that Golden Eagle Retail Group had liabilities of CN¥10.6b due within 12 months and liabilities of CN¥5.42b due beyond that. On the other hand, it had cash of CN¥7.90b and CN¥638.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥7.50b.
When you consider that this deficiency exceeds the company’s CN¥6.04b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Golden Eagle Retail Group boasts net cash, so it’s fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
On the other hand, Golden Eagle Retail Group saw its EBIT drop by 9.0% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Golden Eagle Retail Group can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Golden Eagle Retail 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. Over the last three years, Golden Eagle Retail Group recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
Although Golden Eagle Retail 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¥1.36b. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in CN¥1.4b. So we are not troubled with Golden Eagle Retail Group’s debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. Be aware that Golden Eagle Retail Group is showing 1 warning sign in our investment analysis , you should know about…
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
Valuation is complex, but we’re helping make it simple.
Find out whether Golden Eagle Retail Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
View the Free Analysis
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.