Huafon Microfibre (Shanghai) (SZSE:300180) Is Carrying A Fair Bit Of Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Huafon Microfibre (Shanghai) Co., Ltd. (SZSE:300180) 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?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Huafon Microfibre (Shanghai)

What Is Huafon Microfibre (Shanghai)'s Debt?

The chart below, which you can click on for greater detail, shows that Huafon Microfibre (Shanghai) had CN¥1.93b in debt in March 2024; about the same as the year before. On the flip side, it has CN¥254.2m in cash leading to net debt of about CN¥1.67b.

A Look At Huafon Microfibre (Shanghai)'s Liabilities

We can see from the most recent balance sheet that Huafon Microfibre (Shanghai) had liabilities of CN¥2.04b falling due within a year, and liabilities of CN¥708.1m due beyond that. Offsetting this, it had CN¥254.2m in cash and CN¥1.07b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.42b.

While this might seem like a lot, it is not so bad since Huafon Microfibre (Shanghai) has a market capitalization of CN¥6.50b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Huafon Microfibre (Shanghai) will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Huafon Microfibre (Shanghai) wasn't profitable at an EBIT level, but managed to grow its revenue by 18%, to CN¥4.8b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Huafon Microfibre (Shanghai) had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥94m. 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¥182m into a profit. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Huafon Microfibre (Shanghai) (1 is significant!) that you should be aware of before investing here.

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.