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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Financial Street Holdings Co., Ltd. (SZSE:000402) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Financial Street Holdings

What Is Financial Street Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Financial Street Holdings had CN¥72.7b of debt in June 2024, down from CN¥76.1b, one year before. However, because it has a cash reserve of CN¥13.2b, its net debt is less, at about CN¥59.5b.

How Strong 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¥26.4b due within 12 months and liabilities of CN¥73.6b due beyond that. Offsetting these obligations, it had cash of CN¥13.2b as well as receivables valued at CN¥7.34b due within 12 months. So its liabilities total CN¥79.5b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥9.50b 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'd watch its balance sheet closely, without a doubt. After all, Financial Street Holdings would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Financial Street Holdings's ability to maintain a healthy balance sheet going forward. 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 reported revenue of CN¥17b, which is a gain of 7.0%, 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

Over the last twelve months Financial Street Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable CN¥2.1b at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. 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¥3.2b in the last year. So we think buying this stock is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Financial Street Holdings (1 is concerning) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.