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.' 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 can see that Henan Ancai Hi-Tech Co.,Ltd (SHSE:600207) does use debt in its business. But the real question is whether this debt is making the company risky.
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Henan Ancai Hi-TechLtd Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2024 Henan Ancai Hi-TechLtd had CN¥2.31b of debt, an increase on CN¥1.96b, over one year. On the flip side, it has CN¥707.0m in cash leading to net debt of about CN¥1.60b.
How Strong Is Henan Ancai Hi-TechLtd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Henan Ancai Hi-TechLtd had liabilities of CN¥2.40b due within 12 months and liabilities of CN¥1.38b due beyond that. Offsetting this, it had CN¥707.0m in cash and CN¥1.40b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.68b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Henan Ancai Hi-TechLtd has a market capitalization of CN¥5.37b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Henan Ancai Hi-TechLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Henan Ancai Hi-TechLtd made a loss at the EBIT level, and saw its revenue drop to CN¥4.6b, which is a fall of 15%. We would much prefer see growth.
Caveat Emptor
Not only did Henan Ancai Hi-TechLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥77m at the EBIT level. 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. Another cause for caution is that is bled CN¥721m in negative free cash flow over the last twelve months. So in short it's a really risky stock. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Henan Ancai Hi-TechLtd's profit, revenue, and operating cashflow have changed over the last few years.
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.
