Rongsheng Petrochemical (SZSE:002493) Has Debt But No Earnings; Should You Worry?

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.' 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 Rongsheng Petrochemical Co., Ltd. (SZSE:002493) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Rongsheng Petrochemical

What Is Rongsheng Petrochemical's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Rongsheng Petrochemical had debt of CN¥214.8b, up from CN¥163.3b in one year. On the flip side, it has CN¥32.5b in cash leading to net debt of about CN¥182.3b.

A Look At Rongsheng Petrochemical's Liabilities

The latest balance sheet data shows that Rongsheng Petrochemical had liabilities of CN¥135.2b due within a year, and liabilities of CN¥139.0b falling due after that. Offsetting these obligations, it had cash of CN¥32.5b as well as receivables valued at CN¥8.02b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥233.6b.

The deficiency here weighs heavily on the CN¥99.4b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Rongsheng Petrochemical would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Rongsheng Petrochemical's ability to maintain a healthy balance sheet going forward. 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 Rongsheng Petrochemical wasn't profitable at an EBIT level, but managed to grow its revenue by 8.7%, to CN¥303b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Rongsheng Petrochemical produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥2.5b. 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. Not least because it burned through CN¥43b in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. Case in point: We've spotted 2 warning signs for Rongsheng Petrochemical 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.