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. As with many other companies Henan Huanghe Whirlwind Co., Ltd. (SHSE:600172) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Henan Huanghe Whirlwind's Debt?
The image below, which you can click on for greater detail, shows that Henan Huanghe Whirlwind had debt of CN¥4.55b at the end of September 2023, a reduction from CN¥4.86b over a year. However, it does have CN¥773.4m in cash offsetting this, leading to net debt of about CN¥3.78b.
How Healthy Is Henan Huanghe Whirlwind's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Henan Huanghe Whirlwind had liabilities of CN¥6.08b due within 12 months and liabilities of CN¥455.7m due beyond that. On the other hand, it had cash of CN¥773.4m and CN¥1.13b worth of receivables due within a year. So it has liabilities totalling CN¥4.63b more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's CN¥3.89b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Henan Huanghe Whirlwind'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.
Over 12 months, Henan Huanghe Whirlwind made a loss at the EBIT level, and saw its revenue drop to CN¥2.0b, which is a fall of 20%. That makes us nervous, to say the least.
Caveat Emptor
Not only did Henan Huanghe Whirlwind's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥92m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of CN¥416m. In the meantime, we consider the stock to be risky. For riskier companies like Henan Huanghe Whirlwind 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.