Is Huafu Fashion (SZSE:002042) Using Debt In A Risky Way?

Warren Buffett famously said, '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 the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 Huafu Fashion

What Is Huafu Fashion's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Huafu Fashion had debt of CN¥9.35b, up from CN¥8.59b in one year. However, it does have CN¥3.99b in cash offsetting this, leading to net debt of about CN¥5.36b.

A Look At Huafu Fashion's Liabilities

We can see from the most recent balance sheet that Huafu Fashion had liabilities of CN¥10.1b falling due within a year, and liabilities of CN¥1.17b due beyond that. Offsetting these obligations, it had cash of CN¥3.99b as well as receivables valued at CN¥1.24b due within 12 months. So its liabilities total CN¥6.02b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's CN¥5.68b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Huafu Fashion had a loss before interest and tax, and actually shrunk its revenue by 9.1%, to CN¥12b. That's not what we would hope to see.

Caveat Emptor

Importantly, Huafu Fashion had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥93m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of CN¥458m over the last twelve months. That means it's on the risky side of things. 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. Case in point: We've spotted 2 warning signs for Huafu Fashion you should be aware of, and 1 of them is a bit concerning.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.