Is FESCO Group (SHSE:600861) A Risky Investment?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that FESCO Group Co., Ltd. (SHSE:600861) does use debt in its business. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for FESCO Group

What Is FESCO Group's Net Debt?

As you can see below, at the end of March 2024, FESCO Group had CN¥595.4m of debt, up from CN¥403.0m a year ago. Click the image for more detail. But it also has CN¥7.30b in cash to offset that, meaning it has CN¥6.71b net cash.

A Look At FESCO Group's Liabilities

Zooming in on the latest balance sheet data, we can see that FESCO Group had liabilities of CN¥9.21b due within 12 months and liabilities of CN¥224.1m due beyond that. On the other hand, it had cash of CN¥7.30b and CN¥7.31b worth of receivables due within a year. So it can boast CN¥5.19b more liquid assets than total liabilities.

This excess liquidity is a great indication that FESCO Group's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that FESCO Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Although FESCO Group made a loss at the EBIT level, last year, it was also good to see that it generated CN¥617m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if FESCO Group 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. FESCO Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last year, FESCO Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that FESCO Group has net cash of CN¥6.71b, as well as more liquid assets than liabilities. So we don't have any problem with FESCO Group's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for FESCO Group (1 can't be ignored!) 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.