Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that China Railway Prefabricated Construction Co., Ltd. (SZSE:300374) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.
What Is China Railway Prefabricated Construction's Debt?
You can click the graphic below for the historical numbers, but it shows that China Railway Prefabricated Construction had CN¥1.16b of debt in March 2024, down from CN¥1.23b, one year before. On the flip side, it has CN¥250.9m in cash leading to net debt of about CN¥908.7m.
How Healthy Is China Railway Prefabricated Construction's Balance Sheet?
The latest balance sheet data shows that China Railway Prefabricated Construction had liabilities of CN¥2.33b due within a year, and liabilities of CN¥50.9m falling due after that. Offsetting this, it had CN¥250.9m in cash and CN¥1.25b in receivables that were due within 12 months. So it has liabilities totalling CN¥874.9m more than its cash and near-term receivables, combined.
China Railway Prefabricated Construction has a market capitalization of CN¥4.13b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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 it is future earnings, more than anything, that will determine China Railway Prefabricated Construction's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year China Railway Prefabricated Construction wasn't profitable at an EBIT level, but managed to grow its revenue by 124%, to CN¥1.7b. So there's no doubt that shareholders are cheering for growth
Caveat Emptor
Despite the top line growth, China Railway Prefabricated Construction still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥127m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of CN¥162m into a profit. So we do think this stock is quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for China Railway Prefabricated Construction that you should be aware of before investing here.
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.
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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.