Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Poly Union Chemical Holding Group Co., Ltd. (SZSE:002037) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Poly Union Chemical Holding Group
What Is Poly Union Chemical Holding Group's Debt?
As you can see below, at the end of June 2023, Poly Union Chemical Holding Group had CN¥6.67b of debt, up from CN¥5.64b a year ago. Click the image for more detail. On the flip side, it has CN¥2.02b in cash leading to net debt of about CN¥4.65b.
A Look At Poly Union Chemical Holding Group's Liabilities
According to the last reported balance sheet, Poly Union Chemical Holding Group had liabilities of CN¥10.4b due within 12 months, and liabilities of CN¥3.39b due beyond 12 months. Offsetting this, it had CN¥2.02b in cash and CN¥8.21b in receivables that were due within 12 months. So its liabilities total CN¥3.59b more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of CN¥4.46b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Poly Union Chemical Holding Group'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 Poly Union Chemical Holding Group wasn't profitable at an EBIT level, but managed to grow its revenue by 13%, to CN¥7.0b. We usually like to see faster growth from unprofitable companies, but each to their own.
Caveat Emptor
Importantly, Poly Union Chemical Holding Group had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥360m. 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. However, it doesn't help that it burned through CN¥415m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Poly Union Chemical Holding Group 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.