Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, DR Corporation Limited (SZSE:301177) does carry debt. But should shareholders be worried about its use of debt?
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
How Much Debt Does DR Carry?
As you can see below, at the end of September 2023, DR had CN¥319.2m of debt, up from CN¥285.1m a year ago. Click the image for more detail. But it also has CN¥5.01b in cash to offset that, meaning it has CN¥4.69b net cash.
A Look At DR's Liabilities
The latest balance sheet data shows that DR had liabilities of CN¥1.03b due within a year, and liabilities of CN¥160.0m falling due after that. Offsetting these obligations, it had cash of CN¥5.01b as well as receivables valued at CN¥84.5m due within 12 months. So it actually has CN¥3.91b more liquid assets than total liabilities.
This luscious liquidity implies that DR's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that DR has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if DR can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, DR made a loss at the EBIT level, and saw its revenue drop to CN¥2.4b, which is a fall of 44%. That makes us nervous, to say the least.
So How Risky Is DR?
While DR lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥31m. 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. 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. Be aware that DR is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...
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.