Dongfeng Motor Group (HKG:489) 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 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 Dongfeng Motor Group Company Limited (HKG:489) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. 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. 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 Dongfeng Motor Group

What Is Dongfeng Motor Group's Net Debt?

As you can see below, at the end of December 2020, Dongfeng Motor Group had CN¥60.6b of debt, up from CN¥43.2b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥73.9b in cash, so it actually has CN¥13.3b net cash.

How Healthy Is Dongfeng Motor Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dongfeng Motor Group had liabilities of CN¥142.1b due within 12 months and liabilities of CN¥33.3b due beyond that. On the other hand, it had cash of CN¥73.9b and CN¥19.9b worth of receivables due within a year. So its liabilities total CN¥81.5b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥52.3b 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, Dongfeng Motor Group would likely require a major re-capitalisation if it had to pay its creditors today. Given that Dongfeng Motor Group has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Dongfeng Motor Group 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.

Over 12 months, Dongfeng Motor Group reported revenue of CN¥108b, which is a gain of 6.8%, 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.

So How Risky Is Dongfeng Motor Group?

Although Dongfeng Motor Group had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of CN¥11b. So taking that on face value, and considering the cash, we don't think its very risky in the near term. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Dongfeng Motor Group (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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. 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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