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.' 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. As with many other companies Nine Dragons Paper (Holdings) Limited (HKG:2689) makes use of debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for Nine Dragons Paper (Holdings)

What Is Nine Dragons Paper (Holdings)'s Net Debt?

As you can see below, at the end of June 2023, Nine Dragons Paper (Holdings) had CN¥56.8b of debt, up from CN¥44.2b a year ago. Click the image for more detail. However, it also had CN¥10.4b in cash, and so its net debt is CN¥46.3b.

How Strong Is Nine Dragons Paper (Holdings)'s Balance Sheet?

According to the last reported balance sheet, Nine Dragons Paper (Holdings) had liabilities of CN¥28.1b due within 12 months, and liabilities of CN¥47.4b due beyond 12 months. On the other hand, it had cash of CN¥10.4b and CN¥10.0b worth of receivables due within a year. So its liabilities total CN¥55.0b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥19.6b 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, Nine Dragons Paper (Holdings) 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 Nine Dragons Paper (Holdings)'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 Nine Dragons Paper (Holdings) had a loss before interest and tax, and actually shrunk its revenue by 12%, to CN¥57b. We would much prefer see growth.

Caveat Emptor

Not only did Nine Dragons Paper (Holdings)'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¥1.8b. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost CN¥2.4b in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Nine Dragons Paper (Holdings) that you should be aware of.

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.