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 Huawen Media Group (SZSE:000793) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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 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. 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 Huawen Media Group
What Is Huawen Media Group's Net Debt?
The image below, which you can click on for greater detail, shows that Huawen Media Group had debt of CN¥2.04b at the end of September 2023, a reduction from CN¥2.28b over a year. However, because it has a cash reserve of CN¥314.1m, its net debt is less, at about CN¥1.72b.
How Healthy Is Huawen Media Group's Balance Sheet?
According to the last reported balance sheet, Huawen Media Group had liabilities of CN¥1.25b due within 12 months, and liabilities of CN¥1.39b due beyond 12 months. On the other hand, it had cash of CN¥314.1m and CN¥693.1m worth of receivables due within a year. So its liabilities total CN¥1.63b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Huawen Media Group has a market capitalization of CN¥4.89b, 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 Huawen Media 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.
Over 12 months, Huawen Media Group made a loss at the EBIT level, and saw its revenue drop to CN¥691m, which is a fall of 13%. That's not what we would hope to see.
Caveat Emptor
While Huawen Media Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥70m. 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¥39m of cash over the last year. So to be blunt we think it is risky. For riskier companies like Huawen Media Group I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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