Is Nanjing Red SunLtd (SZSE:000525) A Risky Investment?

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.' 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. We note that Nanjing Red Sun Co.,Ltd. (SZSE:000525) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Nanjing Red SunLtd

How Much Debt Does Nanjing Red SunLtd Carry?

As you can see below, Nanjing Red SunLtd had CN¥4.39b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CN¥293.0m, its net debt is less, at about CN¥4.10b.

A Look At Nanjing Red SunLtd's Liabilities

We can see from the most recent balance sheet that Nanjing Red SunLtd had liabilities of CN¥7.13b falling due within a year, and liabilities of CN¥1.68b due beyond that. On the other hand, it had cash of CN¥293.0m and CN¥3.15b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.37b.

Given this deficit is actually higher than the company's market capitalization of CN¥4.26b, we think shareholders really should watch Nanjing Red SunLtd'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. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Nanjing Red SunLtd had a loss before interest and tax, and actually shrunk its revenue by 41%, to CN¥3.3b. That makes us nervous, to say the least.

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). Indeed, it lost a very considerable CN¥700m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of CN¥380m. In the meantime, we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Nanjing Red SunLtd that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.