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 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. As with many other companies Forehope Electronic (Ningbo) Co., Ltd. (SHSE:688362) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Forehope Electronic (Ningbo)
What Is Forehope Electronic (Ningbo)'s Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Forehope Electronic (Ningbo) had debt of CN¥3.77b, up from CN¥2.76b in one year. However, it also had CN¥849.1m in cash, and so its net debt is CN¥2.92b.
How Strong Is Forehope Electronic (Ningbo)'s Balance Sheet?
We can see from the most recent balance sheet that Forehope Electronic (Ningbo) had liabilities of CN¥2.35b falling due within a year, and liabilities of CN¥5.02b due beyond that. Offsetting this, it had CN¥849.1m in cash and CN¥639.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.88b.
This is a mountain of leverage relative to its market capitalization of CN¥8.85b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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 Forehope Electronic (Ningbo) 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, Forehope Electronic (Ningbo) made a loss at the EBIT level, and saw its revenue drop to CN¥2.1b, which is a fall of 11%. We would much prefer see growth.
Caveat Emptor
Not only did Forehope Electronic (Ningbo)'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¥217m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any 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¥2.7b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Forehope Electronic (Ningbo) has 2 warning signs we think you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.