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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Xinlun New Materials Co., Ltd. (SZSE:002341) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Xinlun New Materials
How Much Debt Does Xinlun New Materials Carry?
As you can see below, Xinlun New Materials had CN¥1.79b of debt at June 2023, down from CN¥2.70b a year prior. Net debt is about the same, since the it doesn't have much cash.
How Strong Is Xinlun New Materials' Balance Sheet?
According to the last reported balance sheet, Xinlun New Materials had liabilities of CN¥3.07b due within 12 months, and liabilities of CN¥671.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥28.2m as well as receivables valued at CN¥605.9m due within 12 months. So it has liabilities totalling CN¥3.11b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of CN¥4.33b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Xinlun New Materials's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Xinlun New Materials had a loss before interest and tax, and actually shrunk its revenue by 20%, to CN¥781m. To be frank that doesn't bode well.
Caveat Emptor
Not only did Xinlun New Materials's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping CN¥666m. 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. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥17m in negative free cash flow over the last twelve months. So to be blunt we think it is 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. We've identified 2 warning signs with Xinlun New Materials (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.
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.