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.' 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 Lianhe Chemical Technology Co.,Ltd. (SZSE:002250) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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 Lianhe Chemical TechnologyLtd's Debt?
The image below, which you can click on for greater detail, shows that at June 2024 Lianhe Chemical TechnologyLtd had debt of CN¥4.19b, up from CN¥4.01b in one year. On the flip side, it has CN¥1.14b in cash leading to net debt of about CN¥3.05b.
A Look At Lianhe Chemical TechnologyLtd's Liabilities
Zooming in on the latest balance sheet data, we can see that Lianhe Chemical TechnologyLtd had liabilities of CN¥3.43b due within 12 months and liabilities of CN¥3.42b due beyond that. Offsetting this, it had CN¥1.14b in cash and CN¥1.57b in receivables that were due within 12 months. So its liabilities total CN¥4.13b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of CN¥4.45b, so it does suggest shareholders should keep an eye on Lianhe Chemical TechnologyLtd's use of debt. 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 ultimately the future profitability of the business will decide if Lianhe Chemical TechnologyLtd can strengthen its balance sheet over time. 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 Lianhe Chemical TechnologyLtd had a loss before interest and tax, and actually shrunk its revenue by 26%, to CN¥5.8b. To be frank that doesn't bode well.
Caveat Emptor
While Lianhe Chemical TechnologyLtd's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥83m at the EBIT level. 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. 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¥476m. In the meantime, 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 example, we've discovered 1 warning sign for Lianhe Chemical TechnologyLtd that you should be aware of before investing here.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.
