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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Shanghai Hile Bio-Technology Co., Ltd. (SHSE:603718) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Shanghai Hile Bio-Technology's Debt?
As you can see below, Shanghai Hile Bio-Technology had CN¥313.6m of debt at September 2023, down from CN¥390.1m a year prior. However, its balance sheet shows it holds CN¥330.0m in cash, so it actually has CN¥16.4m net cash.
How Healthy Is Shanghai Hile Bio-Technology's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Shanghai Hile Bio-Technology had liabilities of CN¥363.5m due within 12 months and liabilities of CN¥67.1m due beyond that. Offsetting these obligations, it had cash of CN¥330.0m as well as receivables valued at CN¥133.1m due within 12 months. So it actually has CN¥32.4m more liquid assets than total liabilities.
Having regard to Shanghai Hile Bio-Technology's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥5.27b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Shanghai Hile Bio-Technology boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shanghai Hile Bio-Technology'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, Shanghai Hile Bio-Technology made a loss at the EBIT level, and saw its revenue drop to CN¥222m, which is a fall of 37%. That makes us nervous, to say the least.
So How Risky Is Shanghai Hile Bio-Technology?
Although Shanghai Hile Bio-Technology had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of CN¥156m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. 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 example, we've discovered 3 warning signs for Shanghai Hile Bio-Technology (1 is significant!) that you should be aware of before investing here.
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.