Here's Why Nanjing Red SunLtd (SZSE:000525) Can Afford Some Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Nanjing Red Sun Co.,Ltd. (SZSE:000525) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

View our latest analysis for Nanjing Red SunLtd

How Much Debt Does Nanjing Red SunLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Nanjing Red SunLtd had CN¥4.66b of debt, an increase on CN¥4.38b, over one year. However, it also had CN¥253.8m in cash, and so its net debt is CN¥4.41b.

How Strong Is Nanjing Red SunLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Nanjing Red SunLtd had liabilities of CN¥7.13b due within 12 months and liabilities of CN¥1.67b due beyond that. Offsetting this, it had CN¥253.8m in cash and CN¥3.21b in receivables that were due within 12 months. So it has liabilities totalling CN¥5.34b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥7.54b, so it does suggest shareholders should keep an eye on Nanjing Red SunLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is Nanjing Red SunLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Nanjing Red SunLtd had a loss before interest and tax, and actually shrunk its revenue by 12%, to CN¥3.3b. That's not what we would hope to see.

Caveat Emptor

Not only did Nanjing Red SunLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥620m. 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¥386m. So in short it's a really risky stock. 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. For instance, we've identified 3 warning signs for Nanjing Red SunLtd that you should be aware of.

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.

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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.