Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Guizhou Chitianhua Co.,Ltd. (SHSE:600227) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Guizhou ChitianhuaLtd
How Much Debt Does Guizhou ChitianhuaLtd Carry?
The image below, which you can click on for greater detail, shows that at September 2023 Guizhou ChitianhuaLtd had debt of CN¥946.3m, up from CN¥620.2m in one year. However, because it has a cash reserve of CN¥400.5m, its net debt is less, at about CN¥545.8m.
A Look At Guizhou ChitianhuaLtd's Liabilities
According to the last reported balance sheet, Guizhou ChitianhuaLtd had liabilities of CN¥1.65b due within 12 months, and liabilities of CN¥540.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥400.5m as well as receivables valued at CN¥477.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.31b.
Guizhou ChitianhuaLtd has a market capitalization of CN¥4.28b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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 Guizhou ChitianhuaLtd's earnings that will influence how the balance sheet holds up in the future. 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, Guizhou ChitianhuaLtd made a loss at the EBIT level, and saw its revenue drop to CN¥2.3b, which is a fall of 8.0%. That's not what we would hope to see.
Caveat Emptor
Over the last twelve months Guizhou ChitianhuaLtd produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥340m. 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. Another cause for caution is that is bled CN¥36m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. For riskier companies like Guizhou ChitianhuaLtd 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.
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.