Health Check: How Prudently Does Hongyuan Green EnergyLtd (SHSE:603185) Use Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Hongyuan Green Energy Co.,Ltd. (SHSE:603185) 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Hongyuan Green EnergyLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Hongyuan Green EnergyLtd had debt of CN¥2.32b, up from CN¥602.6m in one year. But it also has CN¥9.95b in cash to offset that, meaning it has CN¥7.63b net cash.

How Strong Is Hongyuan Green EnergyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hongyuan Green EnergyLtd had liabilities of CN¥17.8b due within 12 months and liabilities of CN¥1.33b due beyond that. Offsetting these obligations, it had cash of CN¥9.95b as well as receivables valued at CN¥1.14b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥8.08b.

This deficit is considerable relative to its market capitalization of CN¥10.6b, so it does suggest shareholders should keep an eye on Hongyuan Green EnergyLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Hongyuan Green EnergyLtd also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hongyuan Green EnergyLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Check out our latest analysis for Hongyuan Green EnergyLtd

Over 12 months, Hongyuan Green EnergyLtd made a loss at the EBIT level, and saw its revenue drop to CN¥7.6b, which is a fall of 46%. To be frank that doesn't bode well.

So How Risky Is Hongyuan Green EnergyLtd?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Hongyuan Green EnergyLtd lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥3.3b and booked a CN¥2.2b accounting loss. Given it only has net cash of CN¥7.63b, the company may need to raise more capital if it doesn't reach break-even soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Hongyuan Green EnergyLtd's profit, revenue, and operating cashflow have changed over the last few years.

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.