Is Pengdu Agriculture & Animal HusbandryLtd (SZSE:002505) A Risky Investment?

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.' 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. We can see that Pengdu Agriculture & Animal Husbandry Co.,Ltd. (SZSE:002505) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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, 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 Pengdu Agriculture & Animal HusbandryLtd

How Much Debt Does Pengdu Agriculture & Animal HusbandryLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Pengdu Agriculture & Animal HusbandryLtd had CN¥6.06b of debt, an increase on CN¥5.58b, over one year. However, it does have CN¥1.62b in cash offsetting this, leading to net debt of about CN¥4.43b.

A Look At Pengdu Agriculture & Animal HusbandryLtd's Liabilities

We can see from the most recent balance sheet that Pengdu Agriculture & Animal HusbandryLtd had liabilities of CN¥7.93b falling due within a year, and liabilities of CN¥4.05b due beyond that. Offsetting this, it had CN¥1.62b in cash and CN¥4.63b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.72b.

Given this deficit is actually higher than the company's market capitalization of CN¥5.61b, we think shareholders really should watch Pengdu Agriculture & Animal HusbandryLtd's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Pengdu Agriculture & Animal HusbandryLtd's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Pengdu Agriculture & Animal HusbandryLtd made a loss at the EBIT level, and saw its revenue drop to CN¥16b, which is a fall of 16%. That's not what we would hope to see.

Caveat Emptor

Not only did Pengdu Agriculture & Animal HusbandryLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping CN¥593m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of CN¥1.0b. And until that time we think this is a risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Pengdu Agriculture & Animal HusbandryLtd you should know about.

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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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.