Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Renrenle Commercial Group Co.,Ltd. (SZSE:002336) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Renrenle Commercial GroupLtd
What Is Renrenle Commercial GroupLtd's Debt?
As you can see below, at the end of December 2022, Renrenle Commercial GroupLtd had CN¥100.2m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥435.5m in cash, so it actually has CN¥335.4m net cash.
A Look At Renrenle Commercial GroupLtd's Liabilities
According to the last reported balance sheet, Renrenle Commercial GroupLtd had liabilities of CN¥2.77b due within 12 months, and liabilities of CN¥1.97b due beyond 12 months. Offsetting this, it had CN¥435.5m in cash and CN¥72.4m in receivables that were due within 12 months. So its liabilities total CN¥4.24b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of CN¥6.12b, so it does suggest shareholders should keep an eye on Renrenle Commercial GroupLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Renrenle Commercial GroupLtd boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Renrenle Commercial GroupLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Renrenle Commercial GroupLtd made a loss at the EBIT level, and saw its revenue drop to CN¥4.0b, which is a fall of 22%. To be frank that doesn't bode well.
So How Risky Is Renrenle Commercial GroupLtd?
Although Renrenle Commercial GroupLtd had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥128m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Renrenle Commercial GroupLtd , and understanding them should be part of your investment process.
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.