We Think ABA Chemicals (SZSE:300261) Has A Fair Chunk 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.' 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. As with many other companies ABA Chemicals Corporation (SZSE:300261) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 ABA Chemicals

What Is ABA Chemicals's Net Debt?

As you can see below, at the end of June 2024, ABA Chemicals had CN¥1.14b of debt, up from CN¥885.7m a year ago. Click the image for more detail. However, it does have CN¥344.9m in cash offsetting this, leading to net debt of about CN¥793.9m.

A Look At ABA Chemicals' Liabilities

The latest balance sheet data shows that ABA Chemicals had liabilities of CN¥1.47b due within a year, and liabilities of CN¥293.3m falling due after that. On the other hand, it had cash of CN¥344.9m and CN¥748.2m worth of receivables due within a year. So it has liabilities totalling CN¥672.0m more than its cash and near-term receivables, combined.

Of course, ABA Chemicals has a market capitalization of CN¥5.81b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. When analysing debt levels, the balance sheet is the obvious place to start. But it is ABA Chemicals's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year ABA Chemicals had a loss before interest and tax, and actually shrunk its revenue by 42%, to CN¥1.0b. To be frank that doesn't bode well.

Caveat Emptor

While ABA Chemicals's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥215m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥227m in negative free cash flow over the last twelve months. So suffice it to say we do 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 example ABA Chemicals has 3 warning signs (and 2 which make us uncomfortable) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.