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.' 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. As with many other companies Mabpharm Limited (HKG:2181) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Mabpharm
How Much Debt Does Mabpharm Carry?
The image below, which you can click on for greater detail, shows that at December 2022 Mabpharm had debt of CN¥129.7m, up from CN¥739.0k in one year. However, because it has a cash reserve of CN¥48.6m, its net debt is less, at about CN¥81.1m.
How Healthy Is Mabpharm's Balance Sheet?
According to the last reported balance sheet, Mabpharm had liabilities of CN¥188.4m due within 12 months, and liabilities of CN¥328.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥48.6m as well as receivables valued at CN¥40.2m due within 12 months. So it has liabilities totalling CN¥427.8m more than its cash and near-term receivables, combined.
Given Mabpharm has a market capitalization of CN¥2.25b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Mabpharm will need earnings to service that debt. 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.
In the last year Mabpharm had a loss before interest and tax, and actually shrunk its revenue by 33%, to CN¥56m. To be frank that doesn't bode well.
Caveat Emptor
While Mabpharm's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥226m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥182m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Mabpharm that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.