Is Hunan New WellfulLtd (SHSE:600975) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Hunan New Wellful Co.,Ltd. (SHSE:600975) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Hunan New WellfulLtd

What Is Hunan New WellfulLtd's Debt?

As you can see below, at the end of September 2024, Hunan New WellfulLtd had CN¥3.20b of debt, up from CN¥2.96b a year ago. Click the image for more detail. However, it does have CN¥1.45b in cash offsetting this, leading to net debt of about CN¥1.76b.

How Strong Is Hunan New WellfulLtd's Balance Sheet?

The latest balance sheet data shows that Hunan New WellfulLtd had liabilities of CN¥2.95b due within a year, and liabilities of CN¥6.28b falling due after that. Offsetting this, it had CN¥1.45b in cash and CN¥225.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥7.56b.

This is a mountain of leverage relative to its market capitalization of CN¥7.83b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hunan New WellfulLtd 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.

Over 12 months, Hunan New WellfulLtd reported revenue of CN¥7.0b, which is a gain of 24%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Hunan New WellfulLtd still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥263m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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¥453m. In the meantime, we consider the stock very risky. For riskier companies like Hunan New WellfulLtd I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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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