Is Nanjing Gaoke (SHSE:600064) Using Debt In A Risky Way?

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.' 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. As with many other companies Nanjing Gaoke Company Limited (SHSE:600064) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Nanjing Gaoke

What Is Nanjing Gaoke's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Nanjing Gaoke had debt of CN¥10.6b, up from CN¥8.06b in one year. On the flip side, it has CN¥3.09b in cash leading to net debt of about CN¥7.54b.

How Healthy Is Nanjing Gaoke's Balance Sheet?

According to the last reported balance sheet, Nanjing Gaoke had liabilities of CN¥14.1b due within 12 months, and liabilities of CN¥4.48b due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.09b as well as receivables valued at CN¥2.17b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥13.4b.

Given this deficit is actually higher than the company's market capitalization of CN¥10.0b, we think shareholders really should watch Nanjing Gaoke's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is Nanjing Gaoke's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Nanjing Gaoke made a loss at the EBIT level, and saw its revenue drop to CN¥3.8b, which is a fall of 28%. That makes us nervous, to say the least.

Caveat Emptor

While Nanjing Gaoke'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¥272m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous 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¥2.2b 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Nanjing Gaoke has 1 warning sign we think you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.