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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Hongmian Zhihui Science and Technology Innovation Co.,Ltd.Guangzhou (SZSE:000523) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's Net Debt?
As you can see below, Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou had CN¥193.1m of debt at September 2023, down from CN¥265.5m a year prior. However, it does have CN¥1.17b in cash offsetting this, leading to net cash of CN¥974.1m.
How Strong Is Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's Balance Sheet?
According to the last reported balance sheet, Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou had liabilities of CN¥351.6m due within 12 months, and liabilities of CN¥1.35b due beyond 12 months. Offsetting this, it had CN¥1.17b in cash and CN¥222.3m in receivables that were due within 12 months. So it has liabilities totalling CN¥314.8m more than its cash and near-term receivables, combined.
Given Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou has a market capitalization of CN¥5.18b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou had a loss before interest and tax, and actually shrunk its revenue by 3.2%, to CN¥2.5b. We would much prefer see growth.
So How Risky Is Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou?
While Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥188m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou that 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.