Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Sichuan Hongda Co.,Ltd (SHSE:600331) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Sichuan HongdaLtd's Debt?
You can click the graphic below for the historical numbers, but it shows that Sichuan HongdaLtd had CN¥714.7m of debt in September 2023, down from CN¥748.9m, one year before. On the flip side, it has CN¥169.5m in cash leading to net debt of about CN¥545.1m.
How Healthy Is Sichuan HongdaLtd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Sichuan HongdaLtd had liabilities of CN¥1.68b due within 12 months and liabilities of CN¥22.7m due beyond that. Offsetting these obligations, it had cash of CN¥169.5m as well as receivables valued at CN¥202.8m due within 12 months. So its liabilities total CN¥1.33b more than the combination of its cash and short-term receivables.
Of course, Sichuan HongdaLtd has a market capitalization of CN¥14.4b, 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 you can't view debt in total isolation; since Sichuan HongdaLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Sichuan HongdaLtd wasn't profitable at an EBIT level, but managed to grow its revenue by 13%, to CN¥3.2b. We usually like to see faster growth from unprofitable companies, but each to their own.
Caveat Emptor
Importantly, Sichuan HongdaLtd had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥20m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of CN¥105m into a profit. 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.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.