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.' 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 Hebei Huijin Group Co., Ltd. (SZSE:300368) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Hebei Huijin Group
What Is Hebei Huijin Group's Debt?
You can click the graphic below for the historical numbers, but it shows that Hebei Huijin Group had CN¥672.9m of debt in June 2023, down from CN¥875.9m, one year before. However, it also had CN¥128.4m in cash, and so its net debt is CN¥544.5m.
How Healthy Is Hebei Huijin Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hebei Huijin Group had liabilities of CN¥1.62b due within 12 months and liabilities of CN¥651.2m due beyond that. Offsetting these obligations, it had cash of CN¥128.4m as well as receivables valued at CN¥1.07b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.07b.
While this might seem like a lot, it is not so bad since Hebei Huijin Group has a market capitalization of CN¥3.71b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But it is Hebei Huijin Group'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.
In the last year Hebei Huijin Group had a loss before interest and tax, and actually shrunk its revenue by 64%, to CN¥401m. To be frank that doesn't bode well.
Caveat Emptor
Not only did Hebei Huijin Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥37m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of CN¥281m into a profit. So in short it's a really risky stock. 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. We've identified 2 warning signs with Hebei Huijin Group , 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.