Lianhe Chemical TechnologyLtd (SZSE:002250) Is Making Moderate Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. 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?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Lianhe Chemical TechnologyLtd

How Much Debt Does Lianhe Chemical TechnologyLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Lianhe Chemical TechnologyLtd had debt of CN¥4.27b, up from CN¥4.05b in one year. However, it does have CN¥1.40b in cash offsetting this, leading to net debt of about CN¥2.87b.

How Strong Is Lianhe Chemical TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Lianhe Chemical TechnologyLtd had liabilities of CN¥3.73b due within 12 months, and liabilities of CN¥3.14b due beyond 12 months. Offsetting this, it had CN¥1.40b in cash and CN¥1.36b in receivables that were due within 12 months. So it has liabilities totalling CN¥4.11b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥5.25b, so it does suggest shareholders should keep an eye on Lianhe Chemical TechnologyLtd's use of debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Lianhe Chemical TechnologyLtd made a loss at the EBIT level, and saw its revenue drop to CN¥5.8b, which is a fall of 17%. We would much prefer see growth.

Caveat Emptor

While Lianhe Chemical TechnologyLtd's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥49m. 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. We would feel better if it turned its trailing twelve month loss of CN¥357m 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. For example - Lianhe Chemical TechnologyLtd has 1 warning sign we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.