Here's Why China Hainan Rubber Industry GroupLtd (SHSE:601118) Can Afford Some Debt

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.' 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, China Hainan Rubber Industry Group Co.,Ltd. (SHSE:601118) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for China Hainan Rubber Industry GroupLtd

What Is China Hainan Rubber Industry GroupLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 China Hainan Rubber Industry GroupLtd had CN¥15.8b of debt, an increase on CN¥14.3b, over one year. However, it does have CN¥5.40b in cash offsetting this, leading to net debt of about CN¥10.4b.

How Healthy Is China Hainan Rubber Industry GroupLtd's Balance Sheet?

The latest balance sheet data shows that China Hainan Rubber Industry GroupLtd had liabilities of CN¥15.2b due within a year, and liabilities of CN¥10.1b falling due after that. Offsetting these obligations, it had cash of CN¥5.40b as well as receivables valued at CN¥2.49b due within 12 months. So it has liabilities totalling CN¥17.4b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥25.6b. 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 it is future earnings, more than anything, that will determine China Hainan Rubber Industry GroupLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year China Hainan Rubber Industry GroupLtd wasn't profitable at an EBIT level, but managed to grow its revenue by 54%, to CN¥46b. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though China Hainan Rubber Industry GroupLtd managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. To be specific the EBIT loss came in at CN¥242m. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of CN¥1.2b and the profit of CN¥372m. So one might argue that there's still a chance it can get things on the right track. 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 China Hainan Rubber Industry GroupLtd (at least 1 which is significant) , 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.