Yahoo Finance Goodbaby International Holdings (HKG:1086) Has A Mountain Of Debt
Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Goodbaby International Holdings Limited (HKG:1086) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Goodbaby International Holdings
What Is Goodbaby International Holdings's Debt?
As you can see below, Goodbaby International Holdings had HK$2.78b of debt, at December 2018, which is about the same the year before. You can click the chart for greater detail. However, it also had HK$930.4m in cash, and so its net debt is HK$1.85b.
A Look At Goodbaby International Holdings's Liabilities
Zooming in on the latest balance sheet data, we can see that Goodbaby International Holdings had liabilities of HK$3.14b due within 12 months and liabilities of HK$2.51b due beyond that. Offsetting this, it had HK$930.4m in cash and HK$1.41b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$3.31b.
Given this deficit is actually higher than the company's market capitalization of HK$2.35b, we think shareholders really should watch Goodbaby International Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
While Goodbaby International Holdings's debt to EBITDA ratio (3.6) suggests that it uses some debt, its interest cover is very weak, at 1.9, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, Goodbaby International Holdings's EBIT was down 22% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Goodbaby International Holdings's ability to maintain a healthy balance sheet going forward. 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Goodbaby International Holdings reported free cash flow worth 7.5% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Our View
On the face of it, Goodbaby International Holdings's level of total liabilities left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And even its conversion of EBIT to free cash flow fails to inspire much confidence. After considering the datapoints discussed, we think Goodbaby International Holdings has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. Given our concerns about Goodbaby International Holdings's debt levels, it seems only prudent to check if insiders have been ditching the stock.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
