Is China Resources Chemical Innovative Materials (SZSE:301090) A Risky Investment?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that China Resources Chemical Innovative Materials Co., Ltd. (SZSE:301090) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China Resources Chemical Innovative Materials

What Is China Resources Chemical Innovative Materials's Debt?

As you can see below, at the end of March 2024, China Resources Chemical Innovative Materials had CN¥152.2m of debt, up from CN¥12.0m a year ago. Click the image for more detail. However, it does have CN¥880.0m in cash offsetting this, leading to net cash of CN¥727.9m.

A Look At China Resources Chemical Innovative Materials' Liabilities

We can see from the most recent balance sheet that China Resources Chemical Innovative Materials had liabilities of CN¥2.84b falling due within a year, and liabilities of CN¥189.0m due beyond that. On the other hand, it had cash of CN¥880.0m and CN¥1.04b worth of receivables due within a year. So it has liabilities totalling CN¥1.11b more than its cash and near-term receivables, combined.

Given China Resources Chemical Innovative Materials has a market capitalization of CN¥12.1b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, China Resources Chemical Innovative Materials boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that China Resources Chemical Innovative Materials's load is not too heavy, because its EBIT was down 89% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Resources Chemical Innovative Materials 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While China Resources Chemical Innovative Materials has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, China Resources Chemical Innovative Materials burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that China Resources Chemical Innovative Materials has CN¥727.9m in net cash. So while China Resources Chemical Innovative Materials does not have a great balance sheet, it's certainly not too bad. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with China Resources Chemical Innovative Materials , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.