Is Hunan Changyuan LicoLtd (SHSE:688779) Using Too Much Debt?

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, Hunan Changyuan Lico Co.,Ltd. (SHSE:688779) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hunan Changyuan LicoLtd

What Is Hunan Changyuan LicoLtd's Debt?

As you can see below, Hunan Changyuan LicoLtd had CN¥3.17b of debt at September 2024, down from CN¥3.65b a year prior. On the flip side, it has CN¥2.76b in cash leading to net debt of about CN¥403.1m.

A Look At Hunan Changyuan LicoLtd's Liabilities

According to the last reported balance sheet, Hunan Changyuan LicoLtd had liabilities of CN¥2.10b due within 12 months, and liabilities of CN¥3.49b due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.76b as well as receivables valued at CN¥3.26b due within 12 months. So it actually has CN¥434.6m more liquid assets than total liabilities.

This surplus suggests that Hunan Changyuan LicoLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hunan Changyuan LicoLtd 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.

Over 12 months, Hunan Changyuan LicoLtd made a loss at the EBIT level, and saw its revenue drop to CN¥6.1b, which is a fall of 55%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Hunan Changyuan LicoLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥317m at the EBIT level. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. But a profit would do more to inspire us to research the business more closely. This one is a bit too risky for our liking. For riskier companies like Hunan Changyuan LicoLtd 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.

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.