Is RongFa Nuclear Equipment (SZSE:002366) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that RongFa Nuclear Equipment Co., Ltd. (SZSE:002366) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for RongFa Nuclear Equipment

How Much Debt Does RongFa Nuclear Equipment Carry?

The image below, which you can click on for greater detail, shows that at September 2024 RongFa Nuclear Equipment had debt of CN¥1.70b, up from CN¥77.5m in one year. However, it does have CN¥1.24b in cash offsetting this, leading to net debt of about CN¥454.9m.

How Strong Is RongFa Nuclear Equipment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that RongFa Nuclear Equipment had liabilities of CN¥1.13b due within 12 months and liabilities of CN¥1.89b due beyond that. On the other hand, it had cash of CN¥1.24b and CN¥1.43b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥350.4m.

Given RongFa Nuclear Equipment has a market capitalization of CN¥9.55b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since RongFa Nuclear Equipment will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year RongFa Nuclear Equipment wasn't profitable at an EBIT level, but managed to grow its revenue by 35%, to CN¥890m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, RongFa Nuclear Equipment still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥23m 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. However, it doesn't help that it burned through CN¥1.4b of cash over the last year. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that RongFa Nuclear Equipment is showing 3 warning signs in our investment analysis , and 1 of those is significant...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.