Xinchen China Power Holdings (HKG:1148) Has Debt But No Earnings; Should You Worry?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that Xinchen China Power Holdings Limited (HKG:1148) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Xinchen China Power Holdings

How Much Debt Does Xinchen China Power Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that Xinchen China Power Holdings had CN¥1.01b of debt in June 2021, down from CN¥1.68b, one year before. However, it also had CN¥483.9m in cash, and so its net debt is CN¥525.5m.

A Look At Xinchen China Power Holdings' Liabilities

The latest balance sheet data shows that Xinchen China Power Holdings had liabilities of CN¥2.39b due within a year, and liabilities of CN¥311.8m falling due after that. Offsetting this, it had CN¥483.9m in cash and CN¥540.2m in receivables that were due within 12 months. So its liabilities total CN¥1.67b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥1.20b, we think shareholders really should watch Xinchen China Power Holdings'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. 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 Xinchen China Power Holdings 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.

In the last year Xinchen China Power Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 15%, to CN¥1.9b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Xinchen China Power Holdings had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CN¥701m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of CN¥698m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. To that end, you should be aware of the 2 warning signs we've spotted with Xinchen China Power Holdings .

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.

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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