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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Zhongfu Information Inc. (SZSE:300659) does carry debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Zhongfu Information
What Is Zhongfu Information's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Zhongfu Information had CN¥285.1m of debt, an increase on CN¥225.2m, over one year. However, because it has a cash reserve of CN¥162.2m, its net debt is less, at about CN¥122.8m.
How Strong Is Zhongfu Information's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Zhongfu Information had liabilities of CN¥548.1m due within 12 months and liabilities of CN¥33.9m due beyond that. Offsetting this, it had CN¥162.2m in cash and CN¥469.9m in receivables that were due within 12 months. So it actually has CN¥50.1m more liquid assets than total liabilities.
Having regard to Zhongfu Information's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥4.73b company is short on cash, but still worth keeping an eye on the balance sheet. 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 Zhongfu Information 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.
Over 12 months, Zhongfu Information made a loss at the EBIT level, and saw its revenue drop to CN¥727m, which is a fall of 30%. That makes us nervous, to say the least.
Caveat Emptor
Not only did Zhongfu Information's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥349m. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. But we'd want to see some positive free cashflow before spending much time on trying to understand the stock. This one is a bit too risky for our liking. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Zhongfu Information you should be aware of, and 1 of them shouldn't be ignored.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.