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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Guoquan Food (Shanghai) Co., Ltd. (HKG:2517) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Guoquan Food (Shanghai) Carry?

You can click the graphic below for the historical numbers, but it shows that Guoquan Food (Shanghai) had CN¥80.3m of debt in December 2023, down from CN¥95.6m, one year before. However, it does have CN¥1.63b in cash offsetting this, leading to net cash of CN¥1.55b.

How Healthy Is Guoquan Food (Shanghai)'s Balance Sheet?

According to the last reported balance sheet, Guoquan Food (Shanghai) had liabilities of CN¥1.17b due within 12 months, and liabilities of CN¥105.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.63b as well as receivables valued at CN¥54.3m due within 12 months. So it actually has CN¥410.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Guoquan Food (Shanghai) could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Guoquan Food (Shanghai) boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Guoquan Food (Shanghai) has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Guoquan Food (Shanghai)'s earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Guoquan Food (Shanghai) 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 two years, Guoquan Food (Shanghai)'s free cash flow amounted to 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guoquan Food (Shanghai) has net cash of CN¥1.55b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 26% over the last year. So is Guoquan Food (Shanghai)'s debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Guoquan Food (Shanghai)'s earnings per share history for free.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.