Is FS Development Investment Holdings (SZSE:300071) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 FS Development Investment Holdings (SZSE:300071) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for FS Development Investment Holdings

What Is FS Development Investment Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 FS Development Investment Holdings had CN¥118.8m of debt, an increase on CN¥11.0m, over one year. On the flip side, it has CN¥53.7m in cash leading to net debt of about CN¥65.1m.

How Strong Is FS Development Investment Holdings' Balance Sheet?

The latest balance sheet data shows that FS Development Investment Holdings had liabilities of CN¥908.7m due within a year, and liabilities of CN¥211.5m falling due after that. On the other hand, it had cash of CN¥53.7m and CN¥1.06b worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that FS Development Investment Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥3.81b company is struggling for cash, we still think it's worth monitoring its balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But it is FS Development Investment Holdings'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.

Over 12 months, FS Development Investment Holdings reported revenue of CN¥1.5b, which is a gain of 16%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, FS Development Investment Holdings had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥15m. 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¥108m in negative free cash flow over the last twelve months. So to be blunt we think it is 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. To that end, you should be aware of the 2 warning signs we've spotted with FS Development Investment Holdings .

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.