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 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. Importantly, Orient Group Incorporation (SHSE:600811) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Orient Group Incorporation's Net Debt?
The image below, which you can click on for greater detail, shows that Orient Group Incorporation had debt of CN¥15.9b at the end of March 2024, a reduction from CN¥17.7b over a year. However, because it has a cash reserve of CN¥2.53b, its net debt is less, at about CN¥13.3b.
How Healthy Is Orient Group Incorporation's Balance Sheet?
We can see from the most recent balance sheet that Orient Group Incorporation had liabilities of CN¥14.9b falling due within a year, and liabilities of CN¥5.89b due beyond that. Offsetting these obligations, it had cash of CN¥2.53b as well as receivables valued at CN¥2.76b due within 12 months. So it has liabilities totalling CN¥15.5b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the CN¥5.41b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Orient Group Incorporation would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is Orient Group Incorporation'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.
In the last year Orient Group Incorporation had a loss before interest and tax, and actually shrunk its revenue by 63%, to CN¥4.6b. To be frank that doesn't bode well.
Caveat Emptor
Not only did Orient Group Incorporation'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¥154m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of CN¥1.5b in the last year. So while it's not wise to assume the company will fail, we do think it's risky. 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. Case in point: We've spotted 2 warning signs for Orient Group Incorporation you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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