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 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, Sichuan Hongda Co.,Ltd (SHSE:600331) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Sichuan HongdaLtd's Net Debt?

As you can see below, Sichuan HongdaLtd had CN¥710.6m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CN¥207.1m, its net debt is less, at about CN¥503.5m.

How Healthy Is Sichuan HongdaLtd's Balance Sheet?

We can see from the most recent balance sheet that Sichuan HongdaLtd had liabilities of CN¥1.74b falling due within a year, and liabilities of CN¥19.3m due beyond that. Offsetting these obligations, it had cash of CN¥207.1m as well as receivables valued at CN¥255.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.30b.

Of course, Sichuan HongdaLtd has a market capitalization of CN¥11.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But it is Sichuan HongdaLtd'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 Sichuan HongdaLtd had a loss before interest and tax, and actually shrunk its revenue by 4.2%, to CN¥2.9b. That's not what we would hope to see.

Caveat Emptor

Importantly, Sichuan HongdaLtd had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥49m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of CN¥110m. So we do think this stock is quite risky. For riskier companies like Sichuan HongdaLtd I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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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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.

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