Health Check: How Prudently Does HongboLtd (SZSE:002229) Use 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.' 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. As with many other companies Hongbo Co.,Ltd. (SZSE:002229) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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.

View our latest analysis for HongboLtd

What Is HongboLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that HongboLtd had CN¥367.4m of debt in September 2024, down from CN¥460.8m, one year before. But on the other hand it also has CN¥652.8m in cash, leading to a CN¥285.4m net cash position.

How Strong Is HongboLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that HongboLtd had liabilities of CN¥1.42b due within 12 months and liabilities of CN¥330.1m due beyond that. Offsetting these obligations, it had cash of CN¥652.8m as well as receivables valued at CN¥251.1m due within 12 months. So it has liabilities totalling CN¥848.1m more than its cash and near-term receivables, combined.

Of course, HongboLtd has a market capitalization of CN¥5.97b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, HongboLtd also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since HongboLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year HongboLtd had a loss before interest and tax, and actually shrunk its revenue by 13%, to CN¥550m. We would much prefer see growth.

So How Risky Is HongboLtd?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months HongboLtd lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥16m and booked a CN¥84m accounting loss. But the saving grace is the CN¥285.4m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with HongboLtd (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.