Is Financial Street Holdings (SZSE:000402) Using Debt In A Risky Way?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Financial Street Holdings Co., Ltd. (SZSE:000402) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Financial Street Holdings

What Is Financial Street Holdings's Net Debt?

As you can see below, Financial Street Holdings had CN¥72.4b of debt at March 2024, down from CN¥82.2b a year prior. On the flip side, it has CN¥12.9b in cash leading to net debt of about CN¥59.5b.

How Healthy Is Financial Street Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Financial Street Holdings had liabilities of CN¥27.9b due within 12 months and liabilities of CN¥72.8b due beyond that. On the other hand, it had cash of CN¥12.9b and CN¥7.52b worth of receivables due within a year. So it has liabilities totalling CN¥80.3b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥7.92b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Financial Street Holdings would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Financial Street Holdings 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.

Over 12 months, Financial Street Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥16b, which is a fall of 15%. We would much prefer see growth.

Caveat Emptor

Not only did Financial Street Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CN¥892m at the EBIT level. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost CN¥2.0b in the last year. So we think buying this stock 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. Be aware that Financial Street Holdings is showing 1 warning sign in our investment analysis , you should know about...

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.

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