Huafu Fashion (SZSE:002042) Is Carrying A Fair Bit Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Huafu Fashion Co., Ltd. (SZSE:002042) does carry debt. But is this debt a concern to shareholders?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Huafu Fashion

What Is Huafu Fashion's Debt?

You can click the graphic below for the historical numbers, but it shows that Huafu Fashion had CN¥7.99b of debt in September 2023, down from CN¥8.44b, one year before. On the flip side, it has CN¥3.91b in cash leading to net debt of about CN¥4.08b.

How Strong Is Huafu Fashion's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Huafu Fashion had liabilities of CN¥8.82b due within 12 months and liabilities of CN¥1.36b due beyond that. On the other hand, it had cash of CN¥3.91b and CN¥1.38b worth of receivables due within a year. So its liabilities total CN¥4.89b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥7.79b, so it does suggest shareholders should keep an eye on Huafu Fashion's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Huafu Fashion can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Huafu Fashion had a loss before interest and tax, and actually shrunk its revenue by 29%, to CN¥12b. That makes us nervous, to say the least.

Caveat Emptor

While Huafu Fashion's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥438m. 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. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CN¥567m. In the meantime, we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Huafu Fashion (1 shouldn't be ignored!) that you should be aware of before investing here.

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.