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.' 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. We note that Shenzhen Overseas Chinese Town Co.,Ltd. (SZSE:000069) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Shenzhen Overseas Chinese TownLtd
What Is Shenzhen Overseas Chinese TownLtd's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Shenzhen Overseas Chinese TownLtd had debt of CN¥137.4b, up from CN¥131.3b in one year. However, because it has a cash reserve of CN¥42.4b, its net debt is less, at about CN¥95.0b.
How Healthy Is Shenzhen Overseas Chinese TownLtd's Balance Sheet?
The latest balance sheet data shows that Shenzhen Overseas Chinese TownLtd had liabilities of CN¥179.7b due within a year, and liabilities of CN¥120.0b falling due after that. On the other hand, it had cash of CN¥42.4b and CN¥32.7b worth of receivables due within a year. So it has liabilities totalling CN¥224.5b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the CN¥24.1b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Shenzhen Overseas Chinese TownLtd would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shenzhen Overseas Chinese TownLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Shenzhen Overseas Chinese TownLtd made a loss at the EBIT level, and saw its revenue drop to CN¥79b, which is a fall of 3.9%. We would much prefer see growth.
Caveat Emptor
Importantly, Shenzhen Overseas Chinese TownLtd had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable CN¥3.9b at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the fact is that it incinerated CN¥1.2b of cash in the last twelve months, and has precious few liquid assets in comparison to its liabilities. So is this a high risk stock? We think so, and we'd avoid it. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Shenzhen Overseas Chinese TownLtd that 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.