Is Shenzhen Huakong Seg (SZSE:000068) Using Too Much 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. Importantly, Shenzhen Huakong Seg Co., Ltd. (SZSE:000068) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Shenzhen Huakong Seg

What Is Shenzhen Huakong Seg's Net Debt?

The image below, which you can click on for greater detail, shows that Shenzhen Huakong Seg had debt of CN¥909.3m at the end of September 2024, a reduction from CN¥1.53b over a year. However, it also had CN¥53.6m in cash, and so its net debt is CN¥855.7m.

A Look At Shenzhen Huakong Seg's Liabilities

We can see from the most recent balance sheet that Shenzhen Huakong Seg had liabilities of CN¥1.74b falling due within a year, and liabilities of CN¥1.10b due beyond that. On the other hand, it had cash of CN¥53.6m and CN¥996.1m worth of receivables due within a year. So its liabilities total CN¥1.79b more than the combination of its cash and short-term receivables.

Shenzhen Huakong Seg has a market capitalization of CN¥4.04b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Shenzhen Huakong Seg'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.

In the last year Shenzhen Huakong Seg's revenue was pretty flat, and it made a negative EBIT. While that hardly impresses, its not too bad either.

Caveat Emptor

Importantly, Shenzhen Huakong Seg had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥189m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Surprisingly, we note that it actually reported positive free cash flow of CN¥203m and a profit of CN¥196m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Shenzhen Huakong Seg , and understanding them should be part of your investment process.

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.