Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Arrail Group Limited (HKG:6639) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Arrail Group
What Is Arrail Group's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Arrail Group had debt of CN¥284.7m, up from CN¥159.6m in one year. But it also has CN¥1.08b in cash to offset that, meaning it has CN¥797.7m net cash.
A Look At Arrail Group's Liabilities
According to the last reported balance sheet, Arrail Group had liabilities of CN¥750.1m due within 12 months, and liabilities of CN¥672.8m due beyond 12 months. Offsetting this, it had CN¥1.08b in cash and CN¥273.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥67.5m more than its cash and near-term receivables, combined.
Given Arrail Group has a market capitalization of CN¥2.50b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Arrail Group also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Arrail Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Arrail Group reported revenue of CN¥1.6b, which is a gain of 2.2%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
So How Risky Is Arrail Group?
Although Arrail Group had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥49m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. To that end, you should be aware of the 1 warning sign we've spotted with Arrail Group .
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.