David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Cultural Investment Holdings Co.,Ltd (SHSE:600715) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Cultural Investment HoldingsLtd
What Is Cultural Investment HoldingsLtd's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Cultural Investment HoldingsLtd had CN¥2.22b of debt in September 2023, down from CN¥2.38b, one year before. However, it does have CN¥112.1m in cash offsetting this, leading to net debt of about CN¥2.11b.
How Strong Is Cultural Investment HoldingsLtd's Balance Sheet?
The latest balance sheet data shows that Cultural Investment HoldingsLtd had liabilities of CN¥3.17b due within a year, and liabilities of CN¥928.3m falling due after that. Offsetting these obligations, it had cash of CN¥112.1m as well as receivables valued at CN¥197.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.79b.
This deficit is considerable relative to its market capitalization of CN¥4.60b, so it does suggest shareholders should keep an eye on Cultural Investment HoldingsLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is Cultural Investment HoldingsLtd'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 Cultural Investment HoldingsLtd had a loss before interest and tax, and actually shrunk its revenue by 14%, to CN¥678m. That's not what we would hope to see.
Caveat Emptor
While Cultural Investment HoldingsLtd'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¥468m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of CN¥1.1b into a profit. So to be blunt we do think it is 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 - Cultural Investment HoldingsLtd has 1 warning sign we think you should be aware of.
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.