Is Flower KingEco-Engineering (SHSE:603007) 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 can see that Flower KingEco-Engineering Inc. (SHSE:603007) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Flower KingEco-Engineering

How Much Debt Does Flower KingEco-Engineering Carry?

The image below, which you can click on for greater detail, shows that Flower KingEco-Engineering had debt of CN¥630.9m at the end of September 2024, a reduction from CN¥906.0m over a year. However, because it has a cash reserve of CN¥13.1m, its net debt is less, at about CN¥617.7m.

How Healthy Is Flower KingEco-Engineering's Balance Sheet?

We can see from the most recent balance sheet that Flower KingEco-Engineering had liabilities of CN¥1.89b falling due within a year, and liabilities of CN¥52.0m due beyond that. Offsetting this, it had CN¥13.1m in cash and CN¥1.00b in receivables that were due within 12 months. So its liabilities total CN¥920.7m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Flower KingEco-Engineering is worth CN¥4.08b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But it is Flower KingEco-Engineering's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Flower KingEco-Engineering made a loss at the EBIT level, and saw its revenue drop to CN¥115m, which is a fall of 29%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Flower KingEco-Engineering's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥159m 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¥15m of cash over the last year. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Flower KingEco-Engineering (including 3 which are a bit unpleasant) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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