Is Lianhe Chemical TechnologyLtd (SZSE:002250) Using Debt In A Risky Way?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Lianhe Chemical Technology Co.,Ltd. (SZSE:002250) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Lianhe Chemical TechnologyLtd

How Much Debt Does Lianhe Chemical TechnologyLtd Carry?

As you can see below, at the end of June 2024, Lianhe Chemical TechnologyLtd had CN¥4.19b of debt, up from CN¥4.01b a year ago. Click the image for more detail. However, it does have CN¥1.14b in cash offsetting this, leading to net debt of about CN¥3.05b.

How Healthy Is Lianhe Chemical TechnologyLtd's Balance Sheet?

The latest balance sheet data shows that Lianhe Chemical TechnologyLtd had liabilities of CN¥3.43b due within a year, and liabilities of CN¥3.42b falling due after that. Offsetting this, it had CN¥1.14b in cash and CN¥1.57b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.13b.

This is a mountain of leverage relative to its market capitalization of CN¥4.45b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Lianhe Chemical TechnologyLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Lianhe Chemical TechnologyLtd had a loss before interest and tax, and actually shrunk its revenue by 26%, to CN¥5.8b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Lianhe Chemical TechnologyLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥83m at the EBIT level. 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. We would feel better if it turned its trailing twelve month loss of CN¥476m into a profit. In the meantime, we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Lianhe Chemical TechnologyLtd , 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.