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. We can see that Wellhope Foods Co., Ltd. (SHSE:603609) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Wellhope Foods Carry?

As you can see below, Wellhope Foods had CN¥4.17b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥1.49b in cash, and so its net debt is CN¥2.68b.

A Look At Wellhope Foods' Liabilities

The latest balance sheet data shows that Wellhope Foods had liabilities of CN¥3.81b due within a year, and liabilities of CN¥3.55b falling due after that. On the other hand, it had cash of CN¥1.49b and CN¥1.43b worth of receivables due within a year. So it has liabilities totalling CN¥4.45b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥6.32b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Wellhope Foods's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Wellhope Foods had a loss before interest and tax, and actually shrunk its revenue by 4.2%, to CN¥34b. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Wellhope Foods produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥183m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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¥466m. So to be blunt we do think it is risky. For riskier companies like Wellhope Foods 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.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.