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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that South Manganese Investment Limited (HKG:1091) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is South Manganese Investment's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 South Manganese Investment had debt of HK$4.72b, up from HK$4.02b in one year. However, it does have HK$1.48b in cash offsetting this, leading to net debt of about HK$3.24b.

How Strong Is South Manganese Investment's Balance Sheet?

We can see from the most recent balance sheet that South Manganese Investment had liabilities of HK$7.16b falling due within a year, and liabilities of HK$1.53b due beyond that. On the other hand, it had cash of HK$1.48b and HK$1.42b worth of receivables due within a year. So its liabilities total HK$5.80b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$2.16b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, South Manganese Investment would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is South Manganese Investment'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, South Manganese Investment reported revenue of HK$15b, which is a gain of 2.6%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months South Manganese Investment produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable HK$236m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it vaporized HK$459m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is risky, like walking through a dirty dog park with a mask on. 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. To that end, you should be aware of the 1 warning sign we've spotted with South Manganese Investment .

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.