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 LingNan Eco&Culture-Tourism Co.,Ltd. (SZSE:002717) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for LingNan Eco&Culture-TourismLtd
How Much Debt Does LingNan Eco&Culture-TourismLtd Carry?
As you can see below, LingNan Eco&Culture-TourismLtd had CN¥4.19b of debt, at March 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥712.3m in cash offsetting this, leading to net debt of about CN¥3.48b.
A Look At LingNan Eco&Culture-TourismLtd's Liabilities
We can see from the most recent balance sheet that LingNan Eco&Culture-TourismLtd had liabilities of CN¥11.4b falling due within a year, and liabilities of CN¥1.57b due beyond that. On the other hand, it had cash of CN¥712.3m and CN¥8.81b worth of receivables due within a year. So its liabilities total CN¥3.46b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of CN¥5.39b, so it does suggest shareholders should keep an eye on LingNan Eco&Culture-TourismLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since LingNan Eco&Culture-TourismLtd 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 LingNan Eco&Culture-TourismLtd had a loss before interest and tax, and actually shrunk its revenue by 40%, to CN¥2.6b. That makes us nervous, to say the least.
Caveat Emptor
While LingNan Eco&Culture-TourismLtd'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¥1.2b. 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¥614m of cash over the last year. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for LingNan Eco&Culture-TourismLtd you should know about.
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.